Transcript of Question & Answer Session The Future System for Monetary Policy Implementation

Thank you, Chris. That was a very detailed speech, and I think it’s going to be a document that market participants will continue to refer to in the weeks and months to come because how central banks react to this huge liquidity has been a question that everybody has been trying to understand and, like you said, a lot of these things are still untested as well. I’m going to start off with some questions and then I’ll open to the floor. The first question … you’re talking about moderating the balance sheet size: do we have an idea of how large this is going to be, and by when? It’s a two­-part question.

No, we don’t, is the short answer. What it will depend on is banks’ underlying demand for reserves and, as I suggested in my speech, that may have changed. In the past, they were really used to operating with very small total reserves in the system. Something in the order of $2 billion to $3 billion was a daily outcome for the banking system. Now that they’ve got used to a much larger balance, they might have changed their operations more persistently. That’s something that they’ll learn and it’s something that the system will have to deal with. But the point is having open market operations with full allotment. What that means is that the banks tell us how much they want at the fixed price; as long as they’ve got good collateral, they’ll get that amount. That means that the supply of reserves—in other words, the size of our balance sheet—will be determined by that demand. We know that it’s less than where we are now. We can come up with some rough estimates and the banks can do their own, but we don’t know exactly where it will be. We know we’re there when more of the banks start to show up at our auctions. At the moment, the demand, as I showed in my chart, is fairly low; when that starts to pick up, we know that we’re getting close.

So that is once the system kicks in, like, some months after the system kicks in.

Well, the system is all ready to go and it’s just a matter of transitioning. As our bonds mature and as the TFF gets repaid, the reserves will naturally come down and we’ll get to a point where the banks say, ‘Ah, I don’t have as many reserves as I would like just sitting in my account; I’m going to need to go to the Reserve Bank and get some from their auctions.’ So, when that happens, that’s when we think we’ll know that we’re transitioning from excess to something that’s ample.

Right, okay. The system is largely untested globally as well, right? Like, you mentioned ECB, BoE and Riksbank, they have also introduced it, but then there is no history. What risks do you see with this system?

I think this is going to be the best system for Australia and I don’t envisage significant risks. There’s always some risk, particularly during a transition. I think the reason I’m fairly confident here that the transition will be relatively smooth is because we already have these open market operations at full allotment working. That started, actually, quite a bit earlier in an informal sense. I think it was the Friday, 16 March 2020, when we knew that there were a lot of stresses in the financial system. So we increased at our auctions, which weren’t full allotment; we said, ‘We’ll provide more’ trying to calm markets down. Then banks came to us and asked for way more than that total, and we said, ‘Okay, you can have it.’ So we started early on in that process of this concept of a full allotment auction; you get what you need. But we’ve now got a fixed price. We’ve been doing this for some years and the banks don’t have hesitation in showing up, if they need it. So we don’t have a stigma about banks coming to that main facility and, because of that, we’re confident that they’ll just show up when they need it, and that should smooth the transition.

Right. When you talk about the tools for liquidity management, you have mentioned forex swaps and bonds. Do we have an idea of the mix yet? How do we know that you’re not doing ‘Stealth QE’ in the market?

Well, I’ll come back to the ‘Stealth QE’ comment. But the mix we don’t know. That’s something that we’ll be thinking carefully about in the period ahead. I think a really important consideration, as I kept mentioning, is our footprint in markets depending on what the demand is, the underlying demand. If we were to satisfy all of that just through open market operation repos, that would imply quite a large footprint potentially in those markets, and that might crowd out private sector repo activity, which we don’t want to do. Given that, it might make sense to also underpin the supply with some other tools. FX swaps is one, and you can do that in a way that has minimal interest rate risk. We used to hold a portfolio of bonds as well, and we could hold some of them in bonds; as long as they’re fairly short-dated, they won’t impose much interest rate risk on the RBA. So, it’s balancing that footprint across the different markets and thinking about the risk for the RBA balance sheet itself. So that’s something to be determined.

And ‘Stealth QE’.

‘Stealth QE’. I wouldn’t call it ‘Stealth QE’ at all. People never called it that in the past when we did it. I think the big difference here is that this is to satisfy an operational need. It’s at the very short end of the market. We’re not holding it with the intention of trying to influence rates, particularly further out the curve, and there’s no big announcement during a period of trauma in the financial system or the economy. So it’s holding some bonds; we used to do that. It might be in a slightly higher quantity than in the past—that remains to be seen—but it’s at the short end of the market; whereas QE is kind of out the curve, trying to influence longer term rates and expectations about those rates.

Right. Your balance sheet size peaked in March 2022 and, since then, we have seen $100 billion going away and then, through the rest of this year, we’ll see another $100 billion of TFF unwind and two of the bonds—the April 2024 and November 2024 bonds—mature as well. You’ve said that this particular framework does not have implications for monetary policy but, with this $100 billion moving out of the financial system, do you see any monetary policy implications?

No. It’s happening because of an unwinding of the earlier unconventional policies, but I don’t think that unwinding, particularly with this system, will have implications for pressures and rates in money markets and, therefore, very little to do with financial conditions. The unwinding of the earlier policies—QT itself—is having some effect, some very marginal effect; it’s pretty small. I’ve described in the past that QT is, by design, about as fun as watching paint dry. So it’s designed to have very gentle effects. That’s quite different from QE, where markets are under considerable stress and there are a lot of pressures, and banks are coming in and we’re making a big announcement to say, ‘We’re doing a whole series of things, including this, in order to help calm markets and bring longer rates down.’ This is just letting the bonds roll off nice and slowly. That’s what’s happening here and around world, and I don’t think it’s having implications for our financial conditions in a significant manner.

Okay. Sticking with monetary policy, if you have just one word to describe the RBA’s current monetary policy stance, what is that one word? Neutral, tightening or easing? There are three options.

I would refuse to answer a question based on such a limitation. Economists can’t just use one word.

Okay, you can have more than one word.

Look, the path is uncertain, so maybe ‘uncertain’ is kind of the key thing. We’ve said that the outlook is uncertain. Inflation has come down and it’s moderating, and that’s a good thing; it’s still high, so there’s more work to be done. But demand is weakening, and demand and supply are coming into better balance. That’s what you need in order to see a further moderation in inflation. The central forecasts have that, and they also have a further easing in the tightness in labour market conditions. But none of that’s certain, and there are things that could move in either direction. Given that—given that the interest rate path is uncertain—the Board made the point, quite pointedly, as Michele has said many times, the Governor, we’re not ruling anything in or anything out with regards to rates.

Thanks for that speech this morning. I want to ask about active bond sales; have there been any updates? Noting that Deputy Governor Andrew Hauser has been in the role for about six weeks … has Andrew come into the role with perhaps some fresh thinking around bond sales, and have there been any developments on that front?

Nothing that I can refer you to. We’ve said that the current approach is to let them mature but, periodically, come back to consider that case. So, when we do, we’ll let you know. That’s a decision of the whole Board and there are a number of different considerations to think about. But, again—I think I also said this recently—just like the current approach to the bonds maturing being about as interesting as watching paint dry; active QT, if the Board were to pursue it, would be, by design, about as fun as watching paint dry but maybe with the window cracked open, but not much more fun than that.

You mentioned on the graph several times ‘foreign reserves’. You noted that the FX market had come under some stress in 2020, and yet it feels like the RBA has not focused at all on intervention in currency markets as going some way to alleviating the pressure on monetary policy and, for that matter, to reducing the amount of liabilities required. It looked to me on the graph that our foreign assets increased during a time of currency stress. Why has the RBA effectively forgotten about the FX market? That is question 1. Question 2: if the reason is that you don’t think you have any control in the FX market, what, other than 2020, are our foreign reserves for? Should we just get rid of all of our foreign reserves—if we’re just saying the superannuation section buys so many offshore assets every month that we can’t do anything about the Aussie dollar being lower than it otherwise could be, hence we are importing inflation—or, lastly, should we just hire some more people in the FX section of the RBA?

I would disagree with your characterisation of the FX market during the pandemic, particularly with regard to the Aussie dollar. It was one market that was actually working relatively well through that period compared to government bond markets, which were not, so we didn’t see a need for intervention. There were some pressures elsewhere and, in order that those pressures didn’t build, central banks together, with the Fed sort of leading the way, provided the option for US dollar swaps to help alleviate that pressure. So we provided an auction where banks could bid for US dollars that would have been provided, through us, through the Fed. Demand was extremely low, showing that there were very limited pressures here, very limited needs for Aussie banks to obtain US dollars. So I would argue that the markets at that stage were not under a lot of pressure. But that’s not to say that it couldn’t happen in the future, in which case reserves would be potentially useful to alleviate those sorts of pressures, but I didn’t see them at that time.

Can I just have a quick follow-up? I’m not talking about the mechanics of the market; I’m talking about the fact that the RBA appears to no longer consider that foreign exchange intervention, testing and smoothing have any role to play at all, and a hundred per cent of the heavy lifting of the RBA is on monetary policy. Why didn’t the RBA buy spot Aussie?

I just disagree with your characterisation. I don’t think our purchases or otherwise of Aussie would have affected the level of the Aussie dollar in a way that would allow you to not raise interest rates as much. Indeed, you can look at the Bank of Japan: the exchange rate is really being dominated by moves in interest rate differentials. I think that’s true of the Australian economy as well, but thank you.

I have just two questions. If you go back to 2008, world credit markets were closing and there was a real crisis. Since then, we’ve got through that and we’ve got through the pandemic. Do you think, given the sophistication of central banks—the lessons they’ve learnt and the level of sophistication in policy—we can be confident that we won’t have another sort of world liquidity crisis perhaps more of the 2008 variety than the 2020? Secondly, if the ‘two Board’ view of the current government goes ahead, how do you think the new Monetary Policy Board might operate; and could you have a situation where some of the people are very experienced economists and might have their own very different views on some of the technicalities that you’ve outlined? It might be a more perhaps interventionist board or a board with more-aggressive opinions.

In terms of the lessons, particularly from the GFC, I think you cannot rule out stresses that come from some external source impacting economies and, therefore, financial markets. I think what’s important though is what do central banks and other policymakers do in response to that? Very much with the GFC in our mind, when banks were hoarding liquidity back in mid­-March 2020 because of the pandemic and the uncertainties, and not just here but globally, we took those lessons from the GFC and, well before the Board had convened and made those announcements about the package on 20 March—I think it was on the Friday before that or it could have been the Thursday, or I could be mistaken—we just said, ‘Right, we’re here to provide liquidity to the banks; they’ve got plenty of collateral, and what they’re looking for is liquidity,’ and we set up these auctions. We increased the amount that we were willing to provide. Then the banks all said, ‘We need more than that,’ and there and then—right there and then—I remember standing next to Guy Debelle, in front of the screen, saying, ‘Right, we’re just going to trade right through this; we’re just going to provide the banks with the liquidity that they need.’ That’s how our system is designed. Now, that calmed markets for a few days. Then there was our package, and then there was the government’s response and all these other things happening offshore, including what other central banks did; and what you otherwise might have had is a financial crisis, a la the GFC, but that was curtailed very quickly. So I think that’s the lesson: do what you need to do; your job is to provide liquidity to solvent banks with good collateral; do it. Our system now is pretty much how that’s going to be designed. I won’t speculate on the monetary policy committee. It’s still in front parliament and is still to be decided, and we don’t know who the members are. So I’ll let that one pass through, but thanks for the question.

Chris, taking a little longer perspective and injecting a bit of macro into the thinking around this, one consideration, I guess, has been that there’s been a long-run decline in the real neutral interest rate and so, therefore, there’s a greater likelihood that at any point in time, when you need to cut because of an impending recession or whatever, you’re going to hit the lower bound. I think that’s been seen as a consideration for not going back to a corridor system because, if you hit the lower bound and you have to do QE, a corridor system is going to be ineffective, so it’s better to have a system that’s more resilient. So how has the thinking around that been part of the Board’s consideration; and how do you think the ample reserve system will work, when we do at some point hit the lower bound and there’s, presumably, some need for QE or something like that?

Well, on the need for QE, I won’t say much more than that we did that review internally and published that on QE. I think the conclusion is that it wouldn’t be the first thing you’d do, but you certainly wouldn’t rule it out. I think that’s in keeping with, actually, what happened post pandemic. It wasn’t one of the first things that we did; it was one of the later things because, for the Australian economy, we didn’t think it would be quite as effective. We thought it would still have some effect, so the Board pursued it later in 2020, but they pursued other things first. So I think, depending on the circumstances, there are other tools—unconventional, if you like. They might have implications for the balance sheet and I think, very much, an ample system would be sort of more resilient to that. You’d still say that you’re in the same system, even under those stresses; you’d just be increasing the supply of reserves. You might want to also increase the supply from other sources, whether it’s FX swaps or short-term government bond holdings. That was actually the first thing that started early. We started that also before the March 20 announcement of the package; we started saying, ‘These bond markets are dysfunctional; we’re going to come in and buy some bonds to alleviate some of those stresses.’ Again, that would not be consistent with a scarce reserves system. So I think that’s part of the thinking; it’s a bit more resilient.

One of your charts showed that ES balances were drifting down towards around $75 billion by 2028, but I guess, given the maturity of schedule and interbank activity, it’s still possible for those reserves to dwindle down even further. Is the Bank targeting a number for ample reserves; is it sort of between $20 billion and $50 billion, or is it more than that? What happens when you get down to the scarce reserves situation again?

We’ve called it an ‘ample reserve system’ and I think that’s a helpful name to give it. But the other way of thinking about it is that it’s really a fixed price system to try and keep control of the key cash rate. The fixed price system means that, if you’re fixing the price, you’re just going to supply whatever is demanded. So we don’t know when the banks are going to say, ‘Actually, we’ve had large balances in our accounts; we just didn’t need them for our daily payment needs; we didn’t need them for our liquidity purposes.’ At some point though, when they get low enough, they’ll say, ‘Ooh, now we might need some; I might need some through next week; I might need some for tomorrow,’ and they come to our open market operation. So that’s the point at which we know we’re out of the excess, and it’s also the point which stops us getting back to scarce. The banks … they might need them sooner or they might need them later, when ES balances are lower, and you picked a number out of the hat. We just don’t know where that is. We could have some rough estimates. But the banks will learn by doing as well. But the ample reserves, that full allotment option at a fixed price, won’t allow you to get to a scarce reserves system almost by definition.

Can I ask one question, Chris? We had inflation data last week. The monthly inflation number came in at 3.4 per cent and has stayed there for three months; it was the third-straight month of 3.4 per cent. It has a ‘3’ in front of you, so is that encouraging; or is the fact that it has stayed at 3.4 per cent for three months, a sign of stickiness and of concern?

Well, our forecasts embed in them this notion that we’ve had quite a sharp decline in inflation, which is welcome, but then the rest of the distance to get to 2 and a half will take some time; so I think it’s still broadly consistent with our forecasts. But there’s uncertainty around that, and persistence of inflation for various reasons is one risk. But weakness in demand could go the other way, depending on how household consumption behaves from here, for example. So we think the risks are fairly balanced around that central case, but the data flow of late doesn’t cause me to think that we are sort of off that central path.

You’re talking about, under the ample reserves system, the ability of using the full allotment system to sort of alleviate short-term scarcity, but you also mentioned the possibility that changing frequency is needed if there’s a greater demand for reserves at some point. I guess, possibly, there’s the possibility of adjusting the term of the repos development as well maybe. When those changes need to be made, is there any concern that there will be, I guess, a signalling effect that there are broader stresses present in the system, or do you sort of perceive that just running an overall ample liquidity system will normalise access to the MO window enough that there won’t be a negative signalling effect? I guess, I’m just thinking of some of the efforts that the Fed is making to normalise discount window access over there and bring less of a stigma to that—less of an issue in Australia anyway—but I’m just curious on your thoughts.

Well, I think we’ve always managed to run a system where the banks have felt fairly comfortable coming to open market operations back when they were daily under the scarce reserve system and then under the full allotment that we’ve been running for a few years now, so I don’t think that’s an issue. We don’t know what the right frequency should be. It may be more than once a week, because you don’t know when the pressures might arise from time to time, either on the demand or the supply side. They might come sort of just after the Wednesday that we normally run these things, and then would you wait for another Wednesday? Probably not, depending on how extreme those pressures were. You want private markets to work and move liquidity around as best as you can; that’s great. But if the system as a whole was under considerable pressure, you might just schedule more frequent auctions. I don’t think that will be a big deal. Again, that was one of the key points of my speech. This is really about the plumbing; it doesn’t signal anything about financial conditions broadly. Indeed, if you’re trying to avoid scheduling more frequent auctions to avoid stresses, that’s actually going to create the stresses that you’re trying to avoid. The better thing to do is just do what the market needs. But no one has needed to show up daily, so it’s really a waste of everyone’s time at the moment with balances where they are, both on the banks’ side and on our side. But if we need to change it, we can change it, and we can change it in an instant; it would take not much more than a phone call and a quick decision.

I’m just interested in whether you’ve got any comments about the US Treasury mandating repos being cleared? Are there any thoughts about that in Australia or any readthrough to you?

So central clearing?

Central clearing.

I know that it’s something that our staff ponder now and again, particularly in our payments policy, which is responsible for central clearing facilities of substance; and, if we had one of those, it would be of substance. But I don’t have anything I can say at the moment.

I know that we’re talking a lot about financial conditions and I’m just interested in your perspective on global financial conditions. Credit spreads are tight and equity markets are healthy. Is this sort of helping or complicating the RBA’s task and that of other central banks? I guess that I’m also mentioning the Bank of Japan’s decision as well and what effect that might have on financial conditions looking forward.

There are definitely measures and we’ve talked about these including in our recent FSR—and there is some easing in some dimensions of financial conditions: strong equity prices and tight credit spreads. They’re worth looking at and they’re worth thinking about. Markets can always correct when they’re priced quite richly. What does it mean for our financial conditions? Probably not much, and I don’t think it’s complicating our decisions. While these are important dimensions of financial conditions, the much more critical ones are the cash rate, the three-­month BBSW, the short end of the yield curve and the Aussie dollar. So what’s happening in these markets is something that we want to think about, but I don’t think it’s keeping us up at night. There’s not much to say about the Bank of Japan and their decision; it wasn’t unexpected and I think markets are taking it in their stride. The Bank of Japan, in some ways, has disappointed markets because they were looking for more guidance and they’re not getting it, but they’ll tell us when they’re ready. Thank you.