RBA goes unconventional as COVID-19 crises prompts radical policy responses

The economic impact of COVID-19 is unfolding through a series of interconnected crises. In the real economy these will take the form of vicious demand and supply shocks. Although these are now appearing in media reporting and company announcements, the official macro data flow is very much a lagging indicator at this point. Data from China is, however, providing an early indication of the severity of the real economy impact of aggressive measures to control the spread of the virus. A third shock – in the form of financial market turmoil – is already upon us. This week has seen measures of market stress and volatility spike up to GFC-like levels, along with big falls in the dollar and the ASX. Radical times are prompting radical policy measures.

The RBA has cut the cash rate to its effective lower bound, deployed unconventional monetary policy in the form of yield curve control, and introduced a term funding facility for the banking system. Subsequent to last week’s fiscal package from Canberra, and more announcements this week, state governments are also delivering a series of budgetary measures aimed at supporting their economies. The federal government is expected to soon announce further -and likely much larger – measures to build upon last week’s $17.6 billion stimulus package.

Only a short reading list this week, predictably dominated by the coronavirus.

What I’ve been following in Australia . . .

Updated – Sunday 22 March 2020

What happened?

The past several days have brought a range of important new fiscal announcements and initiatives:

• On Friday 20 March, the Government announced that the 2020-21 Budget would be deferred until 6 October this year, given that ‘the high degree of uncertainty surrounding how the virus will evolve and its full economic impacts’ made it ‘extremely difficult to formulate reliable economic and fiscal estimates over the next few months’. It also said that it would lift the debt ceiling from $600 billion to $850 billion to ensure it had enough capacity to continue to respond to the economic impact of COVID-19.
• It also announced $444.6 million to support aged care workforce continuity
• On the same day the ACT Government introduced its ‘initial economic survival package’ worth $137 million
• On Saturday, the Victorian Government announced its own $1.7 billion economic survival package
• And on Sunday, the Federal Government announced its second major stimulus package within the space of a couple of weeks.

The Federal Government’s latest package builds on its $17.6 billion plan announced on 12 March, increasing both the generosity and in some cases the eligibility of the original offer. There are also additional measures, including some designed to lessen the threat of actions that could unnecessarily push businesses into insolvency and force the winding up of a business that, absent the unprecedented economic shock created by the virus, would have been perfectly viable.

This second stimulus package is focused on three main areas:

1. Supporting individuals and households (Estimated cost over the forward estimates: $20.2 billion)

• Income support for individuals in the form of a new, time-limited Coronavirus supplement of $550/fortnight, paid to existing and new recipients of Jobseeker Payment, Youth Allowance Jobseeker, Parenting Payment, Farm Household Allowance and Special Benefit for the next six months. Also reduced means testing, reduced waiting times, accelerated claim process and streamline application. Up to 5,000 new staff for Services Australia to assist delivery (Cost: $14.1 billion)
• Second round of $750 payments to eligible households except for those receiving the Coronavirus supplement (Cost: $4.0 billion)
• Temporary early release of superannuation for individuals in financial stress: access up to $10,000 of super, tax free, before 1 July 2020 and again for a further three months after1 July 2020 (Cost: $1.2 billion)
• Reduce super minimum drawdown rates by 50 per cent for 2019-20 and 2020-21 to increase flexibility for retirees
• Lower social security deeming rates by 0.25 percentage points (Cost: $0.9 billion)

2. Support for businesses (Estimated cost over the forward estimates: $25.2 billion) o/w

• Expansion of Boosting cashflow for employers program, with eligible SMEs with employees now able to receive payments equal to 100 per cent of salary and wages withheld, up from 50 per cent under previous scheme. Increase in maximum total payments from $25,000 to $50,000 and increase in minimum total payments from $2,000 to $10,000; Extend access to previous measure boosting cash flow for employers to cover NFPs, including charities with aggregate annual turnover under $50 million. Introduce second payment under scheme available from 28 July 2020, with payment equal to total of all payments received. (Cost: $25.2 billion or $31.9 billion if include original package payments)
• Measures to provide temporary relief for financially distressed businesses in temporary period of insolvency, with temporarily increased thresholds and more time to respond to creditors and temporary relief from directors’ personal insolvent trading liability

3. Supporting the flow of credit (Estimated cost over the forward estimates: up to $20 billion)

• Establish a loan guarantee arrangement between Government and participating banks to cover immediate cash flow needs of SMEs from early April to 30 September 2020. Government will guarantee 50 per cent of new loans issued by eligible lenders to SMEs.

That’s roughly an additional $65.4 billion in government support for the economy. Add in the $0.7 billion provided in the aviation support package listed in the roundup below, and the total of new commitments rise to $66.1 billion.

Why it matters:

Writing back on Thursday (which now feels like far more than just the few days ago it actually was), I noted that the government had already acknowledged that more fiscal support for the economy would be needed than had been provided in the original package. This weekend duly saw Canberra deliver a much larger tranche of budgetary spending, which brings total federal government commitments up to almost $100 billion, or more than five per cent of GDP. That’s slightly larger as a share of GDP than the fiscal stimulus delivered at the time of the GFC.

Add in the RBA’s new term funding facility (described below) and that gets you to an even larger total, hitting Canberra’s eye-catching declaration of cumulative fiscal and balance sheet support of almost $189 billion or approaching ten per cent of GDP:

First stimulus package: $17.6 billion

Aviation support package: $0.7 billion

AOFM investment package: $15.0 billion

Second fiscal stimulus package: $65.4 billion

Total: $98.8 billion (5.1 per cent of GDP), of which

RBA term lending package: $90 billion (4.6 per cent of GDP)

Adjusted total: $188.8 billion (9.7 per cent of GDP)

I also noted on Thursday that the fiscal response would not only need to be large but would also need to be creative, following monetary policy deep into unconventional territory. The government has been delivering on that front too, with a dramatic increase in the level of benefit payments, for example, along with supportive changes to the administrative process, with regulatory relief for temporarily distressed businesses, and with even larger doses of cash flow and payroll support.

As the Treasurer stated, taken together, these measures are ‘unprecedented', as ‘extraordinary times demand extraordinary measures.’

It’s a sign of just how extraordinary those times now are that – in terms of both the scale and the radical and innovative nature of future fiscal support – we are far from done.

What happened:

The RBA announced a series of measures aimed at responding to the ‘very major impact’ the coronavirus is now having on the economy and the financial system. According to the accompanying statement from Governor Lowe, the RBA’s priority will be ‘to support jobs, incomes and businesses, so that when the health crisis recedes, the country is well placed to recover strongly.’ The package contained four main measures.

1. The cash rate was cut to 0.25 per cent – the rate which the RBA has previously characterised as the effective lower bound for its policy rate. The RBA also said that it ‘will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3 per cent target band.’
2. The RBA set a target for the yield on three-year Australian Government bonds of ‘around 0.25 per cent.’ It aims to hit that target via the purchase of government bonds in the secondary market. The RBA will also purchase government and semi-government bonds across the yield curve to stabilise the market.
3. The central bank introduced a three-year term funding facility of at least $90 billion with funding available at a fixed rate of 0.25 per cent. Authorised deposit-taking institutions (ADIs) will be able to obtain initial funding of up to three per cent of their outstanding credit and will be given access to additional funding if they increase lending to business, especially SMEs. For every extra dollar lent to large business, lenders will have access to an additional dollar of RBA funding. For every extra dollar of loans to SMEs, they will have access to an additional five dollars.
4. Exchange settlement balances at the RBA will now be remunerated at 10bp instead of zero (designed to mitigate the cost to the banking system of the large increase in bank balances expected as a result of the policy package).

Governor Lowe followed up this announcement with a speech later the same afternoon, based around the theme that Australian policymakers were ‘building a bridge’ to get the economy to the other side of the disruption caused by the virus and into recovery mode and stressing that the RBA’s focus was to ‘support jobs, incomes and businesses.’

Why it matters:

It’s another piece of economic history: the RBA has pushed the cash rate down to the effective lower bound and started using unconventional monetary policy tools. Thanks in part to COVID-19, one proud boast of the Australian economy during the global financial crisis (GFC) – that we only do normal monetary policy here – no longer holds. And another boast – that we don’t do recessions anymore – has been hanging by a rapidly fraying thread that now looks doomed to snap.

The central bank’s response to this prospect included one last hurrah for conventional monetary policy: a 25bp cut to the cash rate. Not much on its own, although over the past year, the RBA has delivered 125bp of rate cuts, which arguably represents a ‘substantial easing’, as the governor pointed out in his speech, albeit one mostly targeted at pre-virus weakness in the economy. And note that this is still a lot less than the 425bp of rate cuts deployed to help cushion the economy against the impact of the GFC. Hence the need to turn to the two big unconventional measures announced on Thursday.

The first of these will be widely characterised as a move to Quantitative Easing (QE), even though the governor was at pains to stress that by targeting the yield on three-year government bonds the central bank was focused on a price target, and not either the size of bond purchases or the size of its balance sheet, as would be the case under traditional QE. Rather, and as widely anticipated last week, the RBA has adopted a form of yield curve control (YCC) which will aim to keep the three-year bond yield at ‘around’ the same level as the cash rate. Of course, since the way that the RBA will implement this target is by purchasing bonds in the secondary market and by expanding its balance sheet, for all the non-purists out there, this will still look like a version of QE.

The second big initiative came in the form of the new term lending facility, which is designed both to lower funding costs for the banking system as a whole – and hence cap the cost of credit to firms and households – and to provide an incentive for lenders to supply credit to business, especially SMEs.

The RBA has also ramped up its forward guidance, with the governor stressing that it ‘will maintain the current setting of interest rates until a strong recovery is in place and the achievement of our objectives is clearly in sight.’

Today’s moves by the RBA broadly met market expectations. As such, it’s not clear whether they will be enough to settle nerves in the short term, although at minimum they have at least avoided disappointing those same expectations. It’s also far from clear whether they will be enough to cushion the economy over the coming months as the impact of the virus plays out in the real economy, not least given the high level of uncertainty around what will happen next – a key lesson from the past couple of weeks. And the RBA is still going to need a lot of help from the government in its quest to build that bridge (see below). All those qualifications aside, however, there is no doubt that the central bank has now made a significant and substantial move towards defending the economy.

And, critically, in the words of Governor Lowe, ‘nothing is off the table’ and the bank remains ‘prepared to do whatever is necessary.’

What happened:

There have been a range of new fiscal stimulus measures announced over the past week or so, with the federal government following up last week’s $17.6 billion fiscal stimulus package and $2.4 billion health funding package with two new initiatives.

• Canberra announced a support package for domestic airlines, saying that it would waive $715 million in fees and charges (including aviation fuel excise, air service charges and aviation security charges).
• The federal government also pledged to invest up to $15 billion in support of SME lending, by providing the Australian Office of Financial Management (AOFM) with the capacity to invest in the wholesale funding markets used by small lenders. That will allow the AOFM to purchase a range of asset backed securities, including residential mortgage backed securities. The measure is designed to complement the RBA’s $90 billion term funding facility highlighted above.
• And the government has indicated that another major stimulus package is soon to be announced.

Meanwhile, state governments have also introduced a range of measures designed to prop up activity in their jurisdictions:

• The NSW government has announced a $2.3 billion package, with $700 million in additional funding for NSW health and $1.6 billion in tax cuts to support business and jobs.
• The WA government has delivered a $607 million package aimed at supporting households and small businesses, including $402 million to freeze household fees and charges until at least July 2021.
• Queensland has announced a $500 million loan facility offering low interest (and interest-free for the first 12 months) loans of up to $250,000 to help businesses keep their staff and has also extended a payroll tax deferral until the end of the financial year.
• Tasmania has announced a $420 million package (pdf) targeted at households, small businesses and extra funding for the public sector, including a waiver of payroll tax for the final four months of the financial year for the hospitality, tourism, and seafood industries and interest free loans for small businesses in selected sectors.
• South Australia announced a $350 million package including funding for road and hospital upgrades and for tourism infrastructure and increased funding for the state’s Economic and Business Growth Fund.
• The NT government has announced a $65 million package focused on protecting jobs by encouraging spending on local businesses, including via a grant to homeowners for renovation along with funding for business upgrades, as well as introducing a freeze on government fees and charges.

Why it matters:

In its initial fiscal response to the economic crisis caused by COVID-19, the government got several important things right. There was an increase in funding for the health sector – which of course is at the front line of the fight to respond to the virus. There was money to support the cash flow of SMEs. There were wage subsidies to help firms retain staff. There were cash payments to vulnerable households. There were also incentives to encourage businesses to invest, although given the huge amount of uncertainty around the near-term outlook, the headwinds facing new capital expenditure are now quite severe. But while many of the principles were correct – provide support for the most affected people and firms, help prop up demand and support the medical sector – we know already that the scale was insufficient. The economic and financial market dislocations created by the necessary health policy responses to COVID-19 in the form of social distancing and transport and travel restrictions will be severe. And they will be of an uncertain depth and duration. That means that the scale of financial support required will inevitably be much larger than the first fiscal package: so, more support for businesses to prevent a cascade of shutdowns, bankruptcies and soaring unemployment; more support for households so that they can weather the damage to income flows, balance sheets and confidence; and ongoing support for the absolutely critical health sector.

While the total amount of fiscal stimulus now hitting the economy is starting to add up, and is very welcome, much more will be needed, and Canberra has already indicated that more will be forthcoming. As highlighted in last week’s note, federal government fiscal stimulus at the time of the GFC was equivalent to around 4.5 per cent of GDP (by way of contrast, last week’s stimulus was equivalent to a bit less than one per cent of GDP), and that was in the context of a central bank that was able to deliver 425bp of conventional monetary easing.

The fiscal policy response will also need to be creative: just as the now unfolding hit to the economy is in many ways unprecedented, so will Canberra and the states need to be prepared to respond in innovative and at times unorthodox ways. Measures such as government backed loan guarantees, increased wage support and even direct government purchases should be under ongoing consideration.

The response to COVID-19 has already forced monetary policy into unconventional territory. Fiscal policy is likely to have to follow.

What happened:

The Australian dollar has been sliding over recent weeks, dropping from above US$0.66 on 6 March to below US$0.57 on 19 March. Over the same period, the Trade

Weighted Index (TWI) has fallen from above 57 to below 50.

Why it matters:

The dollar traditionally acts as an important shock absorber for the Australian economy, adjusting in response to adverse external shocks. During both the Asian Financial Crisis and the GFC, for example, our dollar fell sharply both against the US dollar and on a trade-weighted basis. The idea is that a lower dollar works to benefit both import-competing and exporting Australian businesses by boosting their international competitiveness, lifting net exports and supporting economic growth.

This time round, however, the traditional lift may not be available. Of course, even in those past examples, any boost from a lower dollar had to work against slower growth in key trading partners and the general disruption to world trade. But in the current environment, a fall in the currency is going to be unable to offer much uplift to critical exports such as tourism and international education in the face of travel bans and grounded flights. That said, there should still be a helpful boost to margins for commodity exporters.

The dramatic nature of the fall in the dollar in the past few days is also telling us something about the febrile state of global markets. As noted, the dollar acting as a shock absorber is nothing new. And the prospect (now delivered) of unconventional monetary policy from the RBA was another good reason to expect a bout of currency weakness. But the FX markets have also been showing signs of outright disorder and dislocation in recent days as investors have scrambled to get their hands on US dollars, driving the greenback up to record highs. (See also this week’s reading on the dollar credit crunch, below.)

What happened:

The ABS said that it would produce additional products to help measure the economic impact of COVID-19. Recognising that ‘there are sizeable benefits for the community and governments to have access to information about the economic responses of individuals and businesses that is as up-to-date as possible. The ABS has considered what additional, more up-to-date information it can provide, over and above the existing statistical releases.’ The Bureau will now start to publish:

• Preliminary retail turnover data, two weeks ahead of the final monthly estimate;
• A new, short monthly survey of the actual and expected impacts of the virus on businesses;
• Additional analysis of short-term overseas visitors and international students;
• Additional data on monthly and quarterly hours worked; and
• Interactive employment maps to support regional assessments of the potential impact on employment.

The first of these new releases delivered preliminary data on retail turnover in February. This showed turnover rising at 0.4 per cent over the month (seasonally adjusted), an improvement over monthly declines in the preceding two months. Turnover was also up 1.7 per cent over the year.

According to the ABS, February’s rise was most driven by the food retailing industry as supermarkets reported increased demand. Elsewhere, there was weakness in the clothing, footwear and personal accessory retailing, with businesses citing an adverse impact from the virus, along with weakness in the other retailing category, which includes duty free stores and luxury goods retailing, both of which are reliant on overseas visitors and both of which also reported negative impacts from COVID-19.

Why it matters:

Tracking the economy through official data releases always includes an element of driving by looking in the rear-view mirror. That constraint becomes increasingly problematic in times of rapid change, when data from a month or so ago can tell us very little about current conditions (in one sign of how quickly things are moving, the promised additional analysis of short-term overseas arrivals is likely to be rendered rather less interesting after the latest travel ban announced by the government). In that context, the ABS’ efforts to provide more timely readings on the economy is welcome news.

Those new preliminary retail turnover numbers offered an interesting insight into how the early impact of COVID-19 is having quite different implications across the retail sector: the rush of Australians into supermarkets is showing up at the same time as the dearth of international visitor spend. And as social distancing measures continue to unroll, other parts of the retail sector will join those already reporting adverse consequences from the virus.

What happened:

According to the ABS, Australia’s unemployment rate fell to 5.1 per cent in February from 5.3 per cent in January (seasonally adjusted). On a trend basis, the rate was unchanged at 5.1 per cent. The underemployment rate for February also remained unchanged at 8.6 per cent on both a seasonally adjusted and a trend basis.

Employment increased by 26,700 over the month (seasonally adjusted), with full-time employment up by 6,700 persons and part-time employment rising by 20,000 persons.

The participation rate dropped by 0.1 percentage points to 66 per cent while the employment to population ratio remained unchanged at 62.6 per cent.

Monthly hours worked in all jobs fell by three million hours.

Why it matters:

The monthly labour market report has been a key release over the past year, especially given the RBA’s recent focus on the degree of spare capacity in the labour market as part of its deliberations over the future path for interest rates. And in that context, February’s report delivered a positive result, with decent growth in employment and a drop in the unemployment rate. The ABS also reported that there ‘was no notable impact on February 2020 Labour Force statistics resulting from the recent bushfires or COVID-19.’ In the present context, however, the good news from February has little to tell us about the year ahead.

While the resilience of the labour market to the impact of the bushfires is good news, the economic hit from COVID-19 is yet to appear in the data. In particular, the ABS pointed out that the February reference period for the labour market report was in the first half of the month and therefore preceded the steep increases in confirmed cases of COVID-19 in Australia. Labour market readings look destined to deteriorate over coming months as the virus takes its toll on economic activity, with most forecasters now pushing up their projections for unemployment through the year.

What happened:

Australia’s population grew by 1.5 per cent during the year ending 30 September 2019, according to the ABS, rising to 25.5 million people. Natural increase accounted for 37.5 per cent of annual population growth. Net overseas migration accounted for the remaining 62.5 per cent, with 534,100 arrivals and 302,000 departures, resulting in net overseas migration of 232,100 people.

By state, Victoria had the highest population growth rate over the year (two per cent) and the Northern Territory the lowest (minus 0.6 per cent). Natural increase was the major contributor to population change in Western Australia and the Australian Capital Territory while net overseas migration was the major contributor to population change in New South Wales, Victoria, Queensland, South Australia and Tasmania.

Why it matters:

The sizeable role played by net overseas migration means that if the current set of travel restrictions (or similar) is sustained, there will be a substantial slowdown in the rate of population growth.

What happened:

The RBA published the minutes from the 3 March meeting of the Reserve Bank Board, at which the central bank decided to cut the cash rate by 25bp to 0.5 per cent.

According to the minutes, members realised that the spread of COVID-19 was expected to affect global growth in 2020 ‘by more than had been factored into the forecasts presented at the previous meeting…Business conditions in China in February had deteriorated by much more than expected and supplier delivery times had increased sharply, indicating that there had also been disruptions to supply chains…Growth in other Asian economies was also expected to be lower in the March quarter than previously thought, reflecting a combination of lower Chinese domestic demand, less Chinese outbound travel and supply chain disruptions…growth in Australia's major trading partners was expected to be around ½ percentage point lower in 2020 as a result of COVID-19.’

In the case of the domestic economy, the discussion emphasised that ‘economic activity in the first half of 2020 would be significantly affected by the global response to the COVID-19 outbreak’ and later went on to note that ‘… members considered a number of scenarios, including one where the COVID-19 outbreak would be contained in the very near future and where there would be a rapid recovery in economic activity…However, this scenario was considered very unlikely, with the more realistic scenario being that the outbreak would have a significant effect on the Australian economy.’

Why it matters:

In more normal times, the content of the minutes is examined in detail for additional clues as to the RBA’s thinking ahead of the following board meeting. This time, not so much. With the minutes now superseded by the central bank’s policy actions on Thursday, they serve more as an interesting guide as to how thinking at Martin Place was evolving prior to the latest intensification of the financial and economic fallout from the coronavirus.

. . . and what I’ve been following in the global economy

What happened:

The latest set of data out of China confirmed that the coronavirus – and the authorities’ tough response – took a devastating toll on economic activity at the start of this year, as combined data for January and February showed dramatic falls in industrial production, retail sales and fixed asset investment:

• Industrial production in January and February plunged by 13.5 per cent, dropping at the fastest pace on record.
• Retails sales likewise suffered their largest – and first – decline on record, falling by 20.5 per cent.
• And fixed asset investment plummeted by 24.5 per cent, in yet another record move.

Why it matters:

A weak result for the first two months of the year for indicators of China’s economic activity was widely expected: not only did the period include the Lunar New Year holiday but it also captured the disruption triggered by COVID-19. Even so, the actual outcomes were far worse than anticipated, and serve as a warning of the kind of economic pain that likely awaits much of the rest of the world economy as authorities pursue their own efforts to stem the spread of the disease.

What happened:

Global financial market turbulence continued over the past week.

About US$23 trillion has been wiped off the value of global share markets over recent weeks.

Key measures of market volatility such as the so-called ‘fear index’ have jumped to GFC-like levels.

As have indicators of the level of global financial stress.

Why it matters:

Last week’s note pointed out that while the real economy effects of the coronavirus are still unfolding, the financial market shock had already arrived, bringing wealth destruction, tighter financial conditions and falling confidence. The past week’s market turmoil has further reinforced that diagnosis. Worryingly, there’s a 2008-feel to global markets right now.

What I’ve been reading

There’s been relatively little time for reading this week, so this is a rather shorter list than normal. Apologies.

In the New Yorker, John Cassidy offers an economic history lesson for dealing with the coronavirus, with the assistance of Barry Eichengreen.

The WSJ wonders, will COVID-19 prompt a ‘generational war’?

Social distancing may be with us for some time.

Tyler Cowen argues that COVID-19 is ‘ushering in an era when big business will be more important than ever.’ And here is Cowen’s plan for dealing with the virus. Willem Buiter on why monetary policy cannot save us from the coronavirus.

Two interesting pieces from VoxEU. This one looks at what economics has to say about the consequences of the (lack of) incentives to prepare for rare events. And this one examines export restrictions on medical supplies.

Philip Turner looks at the unfolding US dollar credit crunch. See also FT Alphaville on the return of dollar swap lines.

And a little bit of non-COVID-19 content:

The RBA has published the March 2020 Bulletin. As always, lots of interesting-looking articles including pieces on demographic trends and household finances, the widening variation in regional economic conditions, and the road to Australian dollar funding.

Also from the RBA, a speech by Alexandra Heath, Head of the Economic Analysis Department, on skills, technology and the future of work.

Preliminary versions of five papers to appear in the Spring 2020 edition of the Brookings Papers on Economic Activity.