Question

The title "How Monetary Policy Changed in Australia before 18th March 2020".

Could you please explain briefly, but clearly and correctly how the RBA managed the cash rate before 18th March? (In Australia)

Answer 1

Australia's Reserve Bank is in charge of formulating and implementing monetary policy. The Reserve Bank sets the 'cash rate' target, which is the overnight fund market interest rate. The Reserve Bank has also set a yield target for 3-year Australian government bonds since March 2020. Other interest rates in the economy are influenced to varying degrees by these interest rates so monetary policy affects the behavior of borrowers and lenders.

Lower the targeted Cash Rate to 0.25 per cent
In March 2020, the Board of Reserve Bank raising the cash rate twice to 0.25 per cent. This will improve the cash flow of businesses and the entire household market. It also helps with the exchange rate to Australia's trade-exposed industries. At the same time, low interest rates have negative implications for some people , especially those who rely on interest revenue. Such implications have been debated by the Board of the Reserve Bank but the evidence is that lower interest rates favor the economy as a whole. The Board has confirmed that it would not raise the cash rate target until progress towards full employment is made, and is optimistic that inflation will be sustainably within the target range of 2–3 per cent.

Provide cash to the Financial System
The Reserve Bank has used its daily market operations to inject considerable extra liquidity into the financial system. The Bank announced in March 2020 that it will conduct regular one-month, three-month, and six-month repurchase operations as long as market conditions warrant. In April 2020, the Bank announced that, given the substantial liquidity already in the system and the commencement of the Term Funding Facility, daily open market operations are likely to be on a smaller scale in the near term. In order to assist the smooth functioning of Australia's capital markets, the Bank decided in May 2020 to extend the range of eligible collateral for domestic market operations to include Australian dollar securities issued by non-bank corporations with a credit rating of investment grade.

The Reserve Bank is working closely on the coordinated response to COVID-19 with the Australian Government, the Australian Treasury and the financial regulators in Australia. The financial regulators are examining how to adjust the timing of various regulatory initiatives to allow financial institutions to focus on their businesses and to work with their customers. As part of this, the Reserve Bank has put the Analysis of Retail Payments Regulation on hold to reduce demands on industry stakeholders at a time when they are concentrating on resolving the COVID-19 impacts.

Members started their debate with a summary of recent developments at a special meeting to consider options for monetary policy responses to the economic consequences of the novel coronavirus disease (COVID-19). The outbreak has been noted as a public health issue in the first place. Many countries shut their borders and imposed restrictions on companies and individuals to limit COVID-19 spread. This caused the economies around the world to suffer very serious disruption. Capital markets were very volatile and the prices of risky assets had dropped sharply as market investors tried to price the risks, despite their unparalleled existence. After reviewing recent developments in financial markets and the implications for economic activity, members turned to how monetary policy could support Australia 's economy most effectively through the challenging period ahead. Members stated that the primary response to the COVID-19 pandemic was to manage people's health, but other policy arms, which include monetary and fiscal policy, would play a significant role in reducing the economic and financial disruption. Members noted the measures taken by the Bank to support the Australian economy and the functioning of financial markets during the days preceding the meeting. The Governor proposed a package of policy measures that would work together to support the Australian economy through the period ahead. The package focused on ensuring that financing costs throughout the economy were low, and that credit remained available to businesses and households. This would help to build the necessary bridge to economic recovery and support recovery once an outbreak of COVID-19 is contained.

1. A further reduction in the cash rate target to 0.25 per cent.

The proposed reduction to 0.25 per cent in the cash rate would bring the accumulated downturn to 11⁄4 percentage points over the previous year. Members noted that this would be a substantial easing of monetary policy, which had, to date, boosted the cash flow of enterprises and the household sector as a whole and also helped trade-exposed industries through the exchange rate channel. Members acknowledged that very low interest rates had uneven effects and negative consequences for some people – particularly those who rely on interest income – but the evidence was that lower interest rates benefited the community as a whole. Members supported the proposal and agreed that the cash rate would not be increased from its lower level until progress towards full employment is made and there is confidence that inflation will be sustainably within the target range of 2–3 per cent.

2. A target for the yield on 3-year Australian Government bonds of around 0.25 per cent.

Members endorsed the proposal 's purpose and accepted that setting the target at the same pace as the target for the cash rate, namely 25 basis points, would be most sensible, even from a communications perspective. They acknowledged that it was not precisely every day that the target needed to be achieved. Members noted that it could take some time before yields fall from their level to the target over the weeks preceding the meeting – around 45 basis points. Members addressed the importance of the Bank's communication concentrating on how this goal will both benefit the economy in the immediate period and help with a successful recovery once the COVID-19 outbreak is contained. Members thought it likely that the three-year yield target would be maintained until progress towards the Bank's Full Employment and Inflation targets was made. In addition, they expressed the view that eliminating the yield target would be appropriate before the cash rate itself was raised.

3. A term funding facility for the banking system, with particular support for credit to small and medium-sized businesses.

Under the proposed agreement, the Bank will provide approved deposit-taking institutions (ADIs) with a three-year funding agreement at a fixed rate of 0.25%, which was significantly below the current funding costs of borrowers. ADIs will be able to receive initial financing of up to 3% of their current outstanding credit by the end of September 2020, and will have access to additional capital if they expanded loans to companies , in particular small and medium-sized enterprises, which could be used by the end of March 2021. That size was at least $90 billion for the proposed facility. Members supported the suggestion that no additional credit be required to fund growth in housing lending. Members expressed support and discussed some technical aspects of the proposed scheme. They indicated that institutions that access the scheme would need to provide the Bank with qualifying collateral, with haircuts available to provide sufficient risk mitigation.

4. Exchange settlement (ES) balances at the Reserve Bank to be remunerated at 10 basis points, rather than zero as would have been the case under the previous arrangements

The Governor outlined the implications for the cash market from the proposed policy measures. The existing 'corridor scheme' means that the financial institutions keeping balance overnight with the Reserve Bank receive an interest rate of 25 basis points below the cash rate, and if a financial institution is required to borrow overnight from the Reserve Bank, 25 basis points will be paid. If the cash rate were to be reduced to 25 base points, the interest rate on ES deposits will be null. Given the significant increase in the balance sheets held in ES accounts resulting from the combined effect of the Bank 's enhanced liquidity operations, bond purchases and the term funding program, maintaining a zero interest rate on these balance sheets would increase the cost to the bank system. Members supported the continuation of strong policy cooperation between the Bank, federal, state and government agencies. They indicated that it would be important to emphasize in the correspondence from the Bank that the Bank expected a recovery once the COVID-19 outbreak was contained and that the recovery would be helped by the low cost of the recovery funding across the economy.

The Board has agreed on a package of measures, which comprises four elements:

Cash rate drop to 0.25 per cent

The 3-year Australian government bond yield target of 0.25 per cent

Term financing facility to support business lending, in particular small and medium-sized enterprises

The interest rate change, to be 10 basis points, for ES accounts kept by financial institutions at the bank

The steps will be revealed in a media release at 2.30 pm AEDT the following afternoon, March 19, following hearings to ensure alignment of APRA and AOFM related policy announcements. The Governor would provide further elaboration and answer questions at a press conference to be held on the same day at the Bank at 4.00 pm AEDT.