QE and low interest rates won’t stimulate the economy: Quay

Chris Bedingfield

Chris Bedingfield

The Reserve Bank of Australia’s policy in 2019 of cutting interest rates has done little to stimulate the Australian economy, but any attempt at introducing quantitative easing (QE) in 2020 is also doomed to fail, says Chris Bedingfield, principal at Quay Global Investors.

“The big challenge for policy makers in 2020 will be to find new ways to stimulate the economy, as it has become obvious that traditional methods such as cutting rates are not working. But the experience of other countries has shown that quantitative easing also has significant limitations – other than perhaps as a placebo effect,” he said.

“The idea that low interest rates and QE support asset prices sounds intuitively correct (i.e. ‘money printing’), but is not widely supported by observation or the operational realities of monetary policy.

“While many market commentators are predicting further interest rate cuts in 2020, we have serious doubts about the efficacy of this strategy.

“We only need to look at Japan, which moved to a zero interest rate policy in 1995, to see that it just doesn’t work – over the past 30 years, the Nikkei 225 Index has fallen 41 per cent.”

Furthermore, Mr Bedingfield says that those who believe QE is the answer should be careful what they wish for.

“Based on our understanding of the monetary system, along with almost 20 years of international QE evidence, outside a domestic financial crisis it is almost certain that an ‘Aussie QE’ will do nothing.

“We know Japan has used QE since 2001 for little or no inflationary or stimulatory effect. Further, there appears to be little evidence it worked in the US, Europe or the UK.”

Mr Bedingfield said there are a number of myths about QE.

Myth 1 – QE is ‘money printing’, characterised as injecting cash into the economy

The truth is that QE is nothing more than an asset swap between the central bank and the private sector. The swap is one form of monetary instrument (bonds) for another (cash).

Myth 2 – QE will inject new spending power into the economy

Owners of bonds are natural savers – there is scant evidence to show swapping bonds for cash increases spending outcomes in the real economy. 

Myth 3 – QE will force down long-term interest rates

US history – and 10-year bond yields – actually shows that when QE commenced long-term interest rates rose, and when QE ended long-term interest rates fell. 

Myth 4 – QE provides cash for banks to lend

Banks do not need deposits or reserves to lend. They simply need enough regulatory capital (from shareholders) and a sufficient supply of credit-worthy borrowers to create a loan: and the loan creates the deposit. Therefore the mechanics of QE, which adds deposits and reserves in exchange for bonds, do not impact banks’ ability or willingness to extend loans.

Myth 5 – QE drives long-term share market performance

The easy response to this myth is Japan. There, QE has been implemented for 20 years and the equity market remains around 40 per cent below its 1989 peak. Supporters of QE (i.e. Bank of Japan) argue QE has not worked ‘yet’ – but how much more time is needed?

Mr Bedingfield says QE has largely failed to deliver because functionally it operates as a private sector tax aimed at the banking system, the wealthy and anyone that holds a superannuation account.

“QE encourages the sale of low-risk low-yielding assets for even lower-yielding cash, resulting in lower net interest income to the private sector. Where does this income go? To the central bank on the other side of the trade, acquiring higher-yielding bonds for the lower-cost cash.

“In effect, the central bank is making an investment spread at the expense of the natural holders of bonds (including banks and superannuation accounts).

“In Australia, excess capital (profits) are remitted to the treasury – in the same way that cash receipts from the tax office are remitted to the treasury.”

“Investors seeking Aussie QE should be careful what they wish for – essentially, they are asking for the wider economy to be taxed.

“Those expecting Aussie QE to provide economic salvation will be disappointed – QE is not inflationary (because it is not money printing), and it is not stimulatory (it is functionally a tax).

“For the economy to turn the corner, what is needed is a significant federal government fiscal deficit, which is true money printing. Perhaps 2020 will see this wish come true,” Mr Bedingfield says.

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