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How $200 billion is magically created

The Federal Government’s latest fiscal stimulus programme centred around a wage subsidy to help combat the impact on the economy of coronavirus-driven shutdowns has generated much community support.

But how will it be paid for? Can we afford it? How does RBA quantitative easing fit into it? And what are the longer-term consequences in terms of inflation and debt?

A rise in public debt of half a trillion

These are valid questions given that together with the previous two fiscal stimulus packages it will add dramatically to Federal Government’s budget deficit – by around $200 billion over the next year (or about 10% of GDP). And to this needs to be added the hit to public revenue from the economic downturn we are now in. So the total rise in public debt could be $500 billion or so (or about 25% of GDP).

To the question of how it will be paid for the answer is simple: the Government will issue bonds and borrow the money required.

However, there are several things to say on all this.

First, it’s absolutely necessary. In normal circumstances, such a massive public stimulus program and boost to public debt - which is nearly double what we saw in the GFC – could not be justified. But these are not normal times. The hit to economic activity in Australia from the shutdowns could be 10% to 15% of GDP. This requires a similarly-sized stimulus programme to offset it, otherwise we risk doing immeasurable collateral damage to the economy. It will take much longer to recover from such damage, ultimately resulting in an even bigger hit to the budget.

Second, to borrow from classic Keynesian economics, it makes sense for the public sector to borrow from households and businesses at a time when they are stuck at home and can’t spend. Government spending the borrowed funds helps smooth out the economy.

Sure the stimulus won’t stop the virus or spur immediate spending when people are locked up inside but it will help support businesses and household income. Then they can survive this period of hibernation and hopefully bounce back once it comes to an end. The trick for the Federal Government is to curtail the stimulus and its borrowing once the economy bounces back and the private sector starts to borrow again otherwise the competition for funds will boost interest rates and create problems for the economy.

Third, Australia’s public debt is far lower than in other comparable countries. In fact, net public debt as a share of GDP is around a quarter of what it is in comparable advanced economies. See the next chart. So Australia has far greater scope to undertake fiscal stimulus than other comparable countries.

Source: IMF, AMP Capital

Fourth, the cost of borrowing for the Federal Government right now is very low at just 0.25% for three years and 0.75% for 10 years. So it’s not as if the Federal Government is incurring a huge interest bill or ‘crowding out’ private sector borrowing or investment.

Finally, the budget blowout may risk a downgrade in Australia’s AAA sovereign debt rating, but ratings are a bit of a relative game and Australia’s public finances will still look relatively better than others. I would rather a rating downgrade than a deep depression/recession any day … particularly when any downgrade will have no impact on the Federal Government’s cost of borrowing!

How does RBA quantitative easing fit into all this?

The RBA is using printed money to buy government bonds in order to help keep interest rates down. It’s buying these bonds in the secondary market (eg from fund managers) so it’s not directly providing the money to the Government and those bonds still have to be paid back when they mature. So it’s not really ‘helicopter money’, which would see the RBA print money and give it to the Government which it would then spend. But it is aiding the process by helping to keep bond yields down.

In the meantime, the balance sheet of the RBA will rise as it holds more bonds but this is not a major issue unless inflation starts to rise due to all the extra printed money in the system. The Fed, ECB and Bank of Japan have been expanding their balance sheets through QE for years now with no rise in inflation so the RBA presumably has a long way to go in this process before it becomes a problem. In fact if the Fed and others had not been doing QE, their countries would probably be mired in deflation by now. Put simply, there is no magical right or wrong for the level of the RBA’s balance sheet.

Longer-term consequences

When the dust settles, Australia will be left with much higher public debt at maybe around 45-50% of GDP in net terms but this will still be below that in other comparable countries. And it will be the price we paid to (hopefully) minimise the loss of life from the virus and at the same time minimise the hit to people’s livelihoods from the shutdown.

This may necessitate forgoing the next round of tax cuts due in 2022 or imposition of a new deficit levy at some point. And it may put a burden on future generations much as Government spending to fund the war effort in WW2 did. But I reckon that’s a cost most Australian’s are prepared to bear given that not acting now with public support mechanisms would likely lead to a far worse outcome.

 

Dr Shane Oliver is Head of Investment Strategy and Chief Economist at AMP Capital, a sponsor of Firstlinks. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs.

For more articles and papers from AMP Capital, click here.

 

30 Comments
Paul Youngman
April 16, 2020

Governments of right and left always dependent on election funding from the very rich and from corporations, have endlessly repaid by reducing taxes; depleting treasury and lining the pockets of the 3 -5% richest. And this with an ever growing welfare cost Time, once this is over, to redress the treasury and reduce the debt by bringing back death duties (USA levies 40% on estates over $5 million) raising income tax rate to 60% on inc over $1M and higher GST on luxury goods

Emma S
April 05, 2020

I find this difficult to get my head around also. Presumably the Reserve Bank will purchase the majority of these Government bonds via the secondary market, so is not the issuer and the owner of the bonds essentially the same broad entity and what will happen when they mature and need to be paid back?

AlanB
April 04, 2020

Households and businesses will not buy bonds from the government when retained earnings need to supplement an insecure income/cash flow.
If the government wants to sell bonds it will have to tempt buyers with higher interest rates.
Printing money will have an inflationary effect. Look at Zimbabwe and 1920s Germany.
The pandemic panic means we sacrifice our full employment, low interest rates and low inflation for business closures, unemployment, higher interest rates, higher inflation and a massive budget deficit with public debt of 40-50% of GDP to pass on to the kids.
Economists know that policies have cost/benefit trade-offs and all economists should be screaming about the destruction of our economy, suspension of civil liberties and easy going way of way of life for the benefit of saving a few more lives mostly in the unproductive 70+ age group.
How many Australians have died to date from this flu to justify this mass hysteria. 30.
Compare that figure of 30 to all other deaths from accidents, suicide, cancer, flu etc every year and it is clear this is a massive over-reaction based on worst-case, secretive medical modelling, probably after watching too many zombie apocalypse movies on Netflix.

peter w
April 05, 2020

Very glad you're are not running the company Alan B.... and trusting that none of your kith or kin gets the virus and die.... and not from the the flu but severe respiratory ailment usually pneumonia i believe. 

john walker
April 05, 2020

alanB

agree 100% ... but the narrative will go along the lines of ... if we didn't then ... so how lucky we are ... but I reckon if we didn't then nothing much would have happened "death" wise and a lot would have gone on in our market places. 


I hear RNS ICU in Sydney has 4 people in it...... capacity 500 ... panic stations?

Darthvader
April 06, 2020

Don’t think you understand what can happen in a pandemic. ICU fills up, ventilators fully occupied, PPE runs out, Hosp staff go off sick/die (they take years to train). New recruits hard to find. Young & previously healthy people die needlessly.

Wayne Ryan
April 03, 2020

Time to revisit Labor's very mild redistributive policies including imputation credits if this crisis is to be shared equitably.

David Close
April 05, 2020

Yes but if so it should be applied to all receiving imputation credits, not just picking on self-supporting retirees.

Teresa
April 02, 2020

And this disaster is why ‘bail in laws’ allow garnering of Mum and dads savings accounts, passed by 5 of the 7 sitting senators. (How convenient the other 69 suddenly weren’t available to vote). It’s why banks have recently changed their terms and conditions so you can no longer sue them for loss of money and they have power to take your savings without notice. Tell me why the Reserve Bank has been buying up all the bank debt over the last 12 months? I could go on but having watched the steady change of our laws outside the constitutions boundaries has been sickening. Believe me Australia you’ve been set up, how convenient this virus has been for the worlds economies that were already well and truly tanking.

Lakshmi Krishnan
April 02, 2020

All these money being printed will it lead to debasement of the money? What happens to people holding cash in their super waiting for the market to stabilise somewhat?

Rick
April 02, 2020

Maybe when this is all over the Government has a great opportunity to clean up some of the taxes they told us they would remove when we all accepted the GST. Namely Payroll Tax and Stamp Duty. Sure State taxes however currently the PRT is on hold.Lets leave it there for good. If they do it will be replaced with the extra people it allows me to employ.
Cannot remove an income without looking how to fund the hole it would make on the Budget. Lets clean away some of the smaller taxes and simplify it all by a very simple 5% increase in the GST.

Jenny
April 02, 2020

Remember the relentless hype "Labor's big black economic hole" following the GFC. That spending was nothing compared to this. I dread to think of the long term consequences.

Bill
April 02, 2020

Shane, does this mean we may see a return of 'Aussie Bonds' for retail investors?

SMSF Trustee
April 02, 2020

Bill, no need. You can buy Australian Government bonds on the ASX already for retail amounts. "Aussie Bonds" never really worked anyway.

Mario Leotta
April 02, 2020

As a self funded retiree (77 years) and after working for the past 56 years, I through my superfund purchased a property for my retirement. Until a week ago the rent received allowed me to meet my living expenses.
Currently no rent is paid by my tenant, and I sold shares to meet my financial obligations,ie rates ,electricity, insurances etc.
I have placed the property on the market.
We are all in this together, some more than others.
I wish all the very best and good health.

Carl
April 02, 2020

You know what will happen then the government will grab half of your gain been there done that, not happy Jane!

Karl
April 02, 2020

Not if you hold the property through superannuation. Unfortunately not paying for advice cost you more for not doing so. I'm sure it would have been tough paying tax for making a profit, definitely more painful than paying no tax for making a loss....

Karl
April 02, 2020

You should have considered a diversified portfolio rather than putting all you eggs in one basket. Unfortunately too many Australians think of property/brick & mortar as the great financial savior. Might be worthwhile using the proceeds of sale to diversify into other investments more liquid and that have more reliable sources of income. All the best.

Angelina Drobina
April 07, 2020

Mario that is so sad. Surely your tenant is entitled to the job seeker or job keeper payment?

I am sending you best wishes and hoping for a good outcome for you ????

Ian Saines
April 02, 2020

This crisis is unique and has caused a complete evaporation of economic activity. It is an extremely deflationary event. If ever there was a case for “helicopter money” it is this event.
There ought to be strong consideration of the RBA continuing to buy the bonds issued by the government and then cancelling that debt.
The RBA holds the government bonds as assets on its balance sheet. The liability on the other side of the balance sheet is, in effect, Australian banknotes, which the RBA prints.
The cancellation of the debt (up to a certain limit, agreed through bi-partisan discussions) would serve a number of purposes:
- reduce the deflationary impact of the current crisis, which is adding to the problem of stubbornly low inflation for a number of years leading into this event;
- reduce the significant overhang that a large public debt will have post the crisis. It is true that Australia’s public debt is relatively low, but it could be argued that the Australian psyche is programmed to be averse to public debt. I for one think that is a good thing and should be maintained.


There are dangers to my suggestion. First, cancelling debt would potentially create a dangerous precedent for future governments that have a greater propensity to spend even in normal times. Therefore the proposal should be promoted by the independent central bank and endorsed by parliament as a one-off decision.


Second, it could have the effect of creating scepticism among global investors in Australian sovereign bonds. That could be managed through the argument that the only debt cancelled would be that held by the central bank, and bonds held by private investors (and other central banks) would remain due and payable.


Third - there would of course be inflationary risks attached, but that is a risk worth taking in the current circumstances.


The reduction in debt going forward would also create more fire-power to deal with the inevitable future crises.

Gaz
April 02, 2020

It’s despicable the unemployment benefits have been capped for $550 since 1994 for that is all we could afford.. and now Morrison feels he can double unemployment benefits and just give a flat rate of $1500 to employees with many getting a significant pay rise for being at home, fancy not capping it at their normal income up to a max $1500. How about saving the 130 billion dollars of gigantic splurge of government debt later to encourage businesses to rehire once activity can resume.
Even if Australia government debt is low compared to some countries is no excuse to waste. Our household debt to gdp is near the highest in the world, the government should be working on strategies to lower this so we are not so vulnerable in the future.

Jesse Nihill
April 02, 2020

My daughter who is year 12 has a PT job earning $50 a week and is in line to receive a $700 weekly pay increase or a bonus $18,200 over 6 months. She hasn't been stood down and will therefore be earning $250 a week for serving takeaway burgers. Makes no sense.

Mick
April 02, 2020

I've not heard a peep about shredding the tax cuts bestowed on our richest and I believe they will proceed as planned no matter how bad the economic situation becomes.
Many of remember the relentless attacks on the Rudd government as it inject money into our economy and effectively saved us from recession. Never mentioned and Frydenburg was asked about this earlier in the week. His response was he was looking forward not back. Amazing that we have different rules for Labor than we do for coalition governments.
The real question people should be asking is WHY was there never any money for Newstart beggars, WHY were struggling self funded retirees repeatedly attacked attacked and WHY were ordinary Australians refused wage increases when the well off had fast increasing salaries? Clearly this government makes it up as it goes along and all I have witnessed in the past 6 years a Class War whilst the government blamed Labor for running one.
We all hope this works out but it was this government which refused to close the borders early on when the evidence abroad was crystal clear and it was under this government's watch that infected people kept being let into the country with no checks whatsoever. Whose fault is the result?????

Mark
April 02, 2020

Good explanation and the Government is doing the right thing now.

The shame is the wasted opportunity from the last 28 years of a strong domestic economy for the Government to save for (this) rainy day, and thereby reduce the burden of this necessary action on future generations. But hindsight is a wonderful thing...

Mary Woodham
April 02, 2020

Totally agree and where is all that wealth that should should have been put away from the once in a generation resources boom.

Janine
April 02, 2020

This shows the importance of running responsible Government budgets and not having excessive public debt. There is going to be a lot of adjusting to people's expectations.

Phil
April 02, 2020

"" It’s buying these bonds in the secondary market (eg from fund managers) so it’s not directly providing the money to the Government and those bonds still have to be paid back when they mature.""

This is the part I don't understand fully - the RBA owns the bonds - the debt is the Governments that must '' repay' the RBA as it owns the Bonds. The RBA can also print money to give to the government equivalent to the amount to repay the bonds. So, really it's like moving money from your left pocket to your right pocket. The real question therefore, as I see it, is what does all the extra cash in circulation eventually do. If the GFC is any indication, it makes the asset holders richer and creates greater inequality, but creates low unemployment and low long term inflation. Where's Warren Bird when we need him!?

Warren Bird
April 06, 2020

Phil, thanks for the vote of confidence. I'm flat out in my day job, so unfortunately can't take time to write anything here.

BUT, I've introduced Graham to someone far more eminent and far more qualified than me to answer these and other questions about the workings of monetary policy and fiscal policy at times like these. Stay tuned.

I will only say this. The RBA is not the Government. It's government owned, but is an independent statutory authority. If it owns government bonds (which it does, all the time, not just at times like this) then when they mature the Treasury normally will make a payment to the RBA funded by either taxes or the proceeds of a new bond issue to the market.

When that doesn't happen and the RBA effectively writes off the debt, then that is money printing. (We haven't seen ANY money printing for decades - QE is not printing money.) Yes it will ultimately create an increase in nominal GDP. Most likely more of that down the track will be in prices rather than volumes, ie inflation. But the global expert that Graham is talking to will elaborate on that far better than I can.

Phil
April 16, 2020

thanks Warren, I note the article today.

Pedro
October 11, 2020

If the government pays the RBA back the money on all the bonds they hold ( bought in the secondaries, off the commercial banks) does that also includes the small amount of interest attached to those bonds issued by the government originally ? And if that’s the case, what happens to that money ?
Is the money repaid to the RBA all taken out of circulation? And does that include all the interest ?
And do the commercial banks selling the bonds to the RBA sell them at cost ?
Surely they sell them to the RBA at a higher price, making some kind of a profit ?
Otherwise why are they involved ?
And why can’t the RBA just buy the bonds directly from the government ?
Saying the RBA is owned by the government, yet its independently run is bullshit.
Why would the RBA even need to be payed back ? As long as it’s not something that always happening, creating some extra cash for Australians to circulate in our economy isn’t a problem at all.
Making future generations suffer by basically paying more in tax,and paying the RBA back, where it’s then removed from circulation, only hurts the poor and vulnerable, not the fat cats that have plenty.
If the RBA exists for the benefit of all Australians, how about injecting some cash into the economy specifically into the accounts of those that desperately need it, and if it needs to be payed back, its those at the top end of town footing the bill.
Enoughs enough.

 

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