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RBA justifies its QE to QT, but did it drive inflation?

Last week, the Deputy Governor of the Reserve Bank of Australia (RBA), Michelle Bullock, presented on the central bank's shift from quantitative easing (QE) to quantitative tightening (QT) and its implications. She reported that between November 2020 and February 2022, the RBA purchased $281 billion of federal and state bonds through its QE programme, at a time when the federal government was borrowing hundreds of billions to fund pandemic support measures, including the $90 billion JobKeeper programme. It was the main factor (the green bars below) in a massive increase in the RBA's balance sheet.

The RBA bond purchasing programme was part of the $US11 trillion injected into the global economy by major central banks in response to COVID-19. And with inflation now entrenched in major economies around the world, central banks are scurrying to reduce their balance sheets. The shift is on to global QT.

Faced with rampant inflation, the US Federal Reserve has indicated it is prepared to bring on a recession to control prices. It's ironic that central banks spent trillions to stimulate activity during the pandemic and now they are withdrawing trillions to reduce spending. Central banks are now paying for their largesse.

The RBA announced in May this year that with the QE phase of expanding its balance sheet ending, the QT phase would begin. It would do this by allowing its holdings to run down as they mature, reducing the balance sheet gradually.

QE and QT and the impact on inflation

QE involves central banks engaging in large-scale asset purchasing programmes. Government bonds are purchased in the secondary market to lower bond yields and longer-term borrowing costs to provide economic stimulus. Debt purchased is recorded as an asset in the central bank balance sheet, offset by the creation of commercial bank (Exchange Settlement, or ES) reserves recorded as a central bank liability, as this RBA chart shows, the other side of the first chart above.

QE adds to base money in the system, and in doing so runs the risk of igniting inflation if the increase in commercial bank reserves spawns an increase in the broad money supply via lending to the private sector. In suppressing interest rates, it can also inflate asset prices.

Essentially, central banks create base money with QE, in the same way commercial banks create private sector deposits (or broad money) when lending money.

In both instances, entries appear simultaneously on the asset and liability side of their balance sheets, as new money is created.

The RBA’s approach to QT of allowing bonds to mature over time and not reinvest the proceeds is a passive approach. The more aggressive scenario is actively selling its assets back into the secondary market before they mature to reduce its balance sheet more rapidly.

The pace at which QE is unwound, if at all, is of importance. To the extent that QE is not reversed, the actions of the central bank could be perceived to be ‘indirect’ monetary financing. Where monetary financing, as advocated by Modern Monetary Theory (MMT), is the funding of government deficits by money creation, instead of issuing debt or increasing taxes. Because when deficit spending coincides with a QE program, that’s what might appear to be occurring.

How Australia financed its spending

Consider, for example, substantial government spending like the JobKeeper programme. That was financed by issuing debt to the market. At the same time, the RBA purchased debt from the market by creating commercial bank reserves, therefore indirectly financing the Government’s deficit, at least temporarily.

We see here diagrammatically how debt-financed government spending in tandem with a QE program, flows through the relevant balance sheets.

For the purposes of this article, the flow diagram below is one of six in the diagram which shows the flows between balance sheets.


The move from QE to QT

With the RBA balance sheet and government debt rising steeply since early 2020 (see chart below), if at maturity the RBA rolled over that debt, then financing would remain in place. Only when central banks begin to unwind asset purchases and reduce their balance sheets, will monetary financing prove not to be permanent, and be genuine QE.

Now, full QE unwinding may eventually occur around the world, but it may only be partial. With all that has been spent on COVID-19 globally, it is perhaps inevitable that some of that will end up being monetary finance, but central banks will be careful not to make that explicit.

One way to protect a government’s long-term intentions is for the central bank to only trade in the secondary market. That is, with institutions that had already purchased government debt. Indeed, early in its QE programme, the RBA went to great lengths to state that it would not purchase debt directly from the Government (the primary market) to maintain its independence from Treasury.

Minutes of the November 2020 RBA Board Meeting record that:

“the Bank would not purchase bonds directly from the Government, and so the purchase of bonds by the Bank would not constitute government financing.”

And in July 2020, RBA Governor Philip Lowe said:

“I want to make it very clear that monetary financing of fiscal policy is not an option under consideration in Australia.”

Is this 'money printing'?

In reality, however, regardless of whether a central bank purchases debt in the primary or secondary market, a QE programme running parallel to fiscal spending could be viewed as indirect or at least, temporary monetary financing, with the possibility of it becoming permanent.

Optics are often everything though, and with many commentators suspicious of QE, deeming it to be just money printing, free money, and outright brazen, buying in the primary market would not be a good look.

This is why QE only proceeds in the secondary market, downplaying the perception of money printing.

And with the possibility of QE being long term before being unwound, its distinction from monetary financing is often about policy intentions as opposed to how it is implemented.

Independence of the central bank from the Government is important, because without the separation of monetary and fiscal entities, central bankers could fear uncontrolled monetary financing pushed by government, heightening risks such as Weimar Republic-style hyperinflation, that would have devastating economic effects.

Unconventional, experimental - and now comes inflation

These activities by central banks have rightly carried the label of 'unconventional', and they were always an experiment. Prior to the 2007 GFC and COVID-19, unconventional monetary policies such as QE, QT, MTT, and negative interest rates existed more in the realm of the theoretical than the practical. Yet now we have seen much of it implemented with vigour around the world.

The concern with such potent monetary stimulus was always inflation. And now that it has arrived, the challenge for policymakers is to put the inflation genie back in the bottle and decide how mainstream such policies should become going forward while being mindful of supply-side inflation arising from the likes of a pandemic or a war.


Tony Dillon is a freelance writer and former actuary. This article is general information and does not consider the circumstances of any investor.

A version of this article was originally published by The Institute of Actuaries of Australia. 


Stephen W
October 01, 2022

Interesting read. One day, the piper has to be paid and better to rip off the band aid now than leave it and incentivise further debt funded speculation into asset bubbles and consumption that will only cause more paid down the track. It amazes me the number of financial commentators who believe that we should maintain negative “real rates”. That’s what got us into this mess in the first place and to perpetuate these policies is lunacy. We should be mindful of the legacy we leave for the next generation. The current generation has brought forward consumption fuelled by cheap debt and that debt needs to be reduced, ideally repaid, by someone. Why not the generation who has benefited from such policies. Mind you, trouble is brewing in the background and probably won’t be too long now before we see a Lehman repeat. At this point, it is likely that negative real rates and more QE will materialise and the bubbles will continue to inflate. One thing central bankers have proven they don’t have is a backbone…and arguably, any common sense with respect to the dynamics of economics. Central banks should not set the price of money, they should be set by the market.

Tony Dillon
September 29, 2022

Just a footnote to the article and in particular, the comment, "full QE unwinding may eventually occur around the world, but it may only be partial".

Japan is an interesting case in point. Since the 1990s, substantial budget deficits have been accompanied by ongoing QE programs employed by the Bank of Japan (BoJ). To the extent where with public debt currently running at a developed nation high of around 260% of GDP, and a BoJ balance sheet an eye-watering 120%, it is now likely that a large portion of the BoJ’s government debt holdings will be rolled over in perpetuity, locking monetary financing in.

Roland Geitenbeek
September 29, 2022

According to my understanding the 'true definition' of inflation is the creation of FIAT money, that is, printing more currency, either printing banknotes or, crediting the State and Federal Government bank accounts with that amount of money which they can transfer to other accounts and so it is rightly 'printing of money'. The Reserve bank purchased trillions of dollars worth of State and Federal Government debt instruments thereby creating money out of thin air. Reserve banks all over the world are able to do this, sometimes at the direction or coaxing of Government. This is the real cause of inflation. Price rises and falls for commodities, goods and wages are NOT inflation, they are the result of changes in the supply and demand thereof. The Reserve bank Governer and many senior staff at the Reserve bank are highly educated students of economics (perhaps not so much when it comes to understanidn and interpreting history), that aside, surely they would have known that 'creating' that much money in such a short span of time by the Reserve Bank would have created exactly the problem we now have, which by the way is what almost all Resrver banks around the world have done. Another case of history repeating itself with the justification that 'this time it will be different'.

llewellyn judge.
September 29, 2022

Great comment. Is there an issue that the Reserve Bank Governor and his senior staff are public servants and depend upon the politicians for their jobs?

Warren Bird
September 29, 2022

No, Llewellyn there isn't. They have legislative independence. I've known all the Governors from Bernie Fraser on personally and can vouch for their integrity and sense of obligation to the people of Australia over their political overseers.

As for Roland's comment, it's wide of the mark. One branch of economics (the so-called Austrian School) argues that inflation is defined by money supply growth, but they're a minority. To most of us, inflation is the rate of change of the average price level of goods and services in the economy. There's a relationship between money supply growth and price inflation, of course, but the equation is not M = P, but MV = PT. The Velocity of money circulation is not constant and the potential growth of Transactions in the economy can vary as well, so there's a lot more going on in the link between Money and Prices than the Austrian school has proposed. The dynamics flows both ways, too.
All that said, the reality is that around the world the monetary policies in COVID did fuel rapid growth in M. Partly because of government debt monetisation (maybe via secondary channels, but that's what happened) and partly because banks didn't just recycle the funds they were paid by central banks to relieve them of their debt holdings. Lending took off.
Money supply growth in the US, UK, Europe and to a lesser extent Australia, exploded in 2020. (So, to answer the question in the article, yes the RBA did drive inflation higher.)
That money supply trend should have been a clear sign that inflation was imminent - I was one who predicted it, following Prof Tim Congdon here on Firstlinks and in his own global work. Sadly, I'm yet to see money growth referenced in much analysis of the inflation outlook.
In the US it's collapsed and the Fed really does need to slow down its tightening, not accelerate it! In Australia we're still seeing quite rapid broad money growth, though I'll be keen to see the August data for signs that rate hikes have bitten already. The housing market tells us it has, but the rest of the economy is going gangbusters so we'll have to see.

September 29, 2022

Should we enter a depression then the Reserve Bank might feel caused to start checking the reeded edges on all our coins for evidence of scrimpy scrapings to avert a monetary 'meltdown'. 

Mark Hayden
September 28, 2022

Economics is a fascinating science and I note the description that we are in an experiment with negative interest rates, MMT etc. Whilst my focus is purely 10+ years these experiments may have very long term effects. I wonder whether interest rates should normalise at inflation plus, say, 1%; rather than be stuck below inflation (which has been the case since the GFC)?

Tim Farrelly
September 28, 2022

Really useful description of how QE works in practice. However, we didn’t really get a clear answer to the two central questions posed by the article, is QE money printing and did it cause inflation? Using the logic outlined in the article the answers are “no”and “no”. The buying of bonds was financed by borrowing from the commercial banks as we saw in the RBA liabilities chart which would have looked very different if indeed QE was money printing. As for the second question, the fact the world experienced inflation at the same time while QE has been implemented at very different times around the world provides a big clue about lack of cause and effect.

September 28, 2022

Tim Farrelly says: "[...] ...a big clue about lack of cause and effect." Shades of when, prior to the US having officially entered WWII, due to Uncle Sam dragging his feet in remaining neutral, he engineered his "Lend Lease"* program which provided the Brits with weapons etc., (c)ostensibly free-of-charge. Adolf was also into QE somewhat when, using "Operation Bernhard", he decided to flood Britain with dodgy 5 quid notes, many of which 'rag paper' notes came in very handy indeed when used 'undercover to cover' the finance shortfalls in revenue from the Reichsbank. *When one's been gathered to (or gathering) the fold(ing), and ignorant as to exactly where the enemy lurks, the perks are simply that it 'always pays' to do one's best to just sidle up alongside and blend in.

Tony Dillon
September 29, 2022

Thanks for the comment Tim. "Money printing" is a figurative term meaning electronically created money in a QE context. As the article explains, central banks purchase assets by electronically creating commercial bank reserves instantaneously. That action increases base money in the system. The article points out that to the extent a QE program runs in tandem with government spending, then the broad money supply also increases. The link showing how $1 billion flows through balance sheets in such circumstances, concludes that $1 billion makes its way into the private sector via electronically created settlement account money. So to the extent that the $1 billion is not reversed via QT when government spending has occurred simultaneously, then yes, $1 billion has been electronically "printed" with the central bank indirectly financing the government.

As for inflation. The article states, "QE adds to base money in the system, and in doing so runs the risk of igniting inflation if the increase in commercial bank reserves spawns an increase in the broad money supply via lending to the private sector". And indeed we saw an increase in the availability of finance to households and businesses during the pandemic which coupled with low interest rates, saw a substantial increase in asset values. And more broad money generally in the economy, is inflationary without a corresponding increase in goods and services. The sheer volume of QE undertaken globally would have to have been a contributor to the spike in inflation in major economies.


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