In November 2020, the Reserve Bank Board introduced a Bond Purchase Program (BPP) as part of a second monetary policy package aimed at lowering Australia’s interest rate structure. This package was implemented to provide additional support for job creation and the recovery of the Australian economy from the COVID-19[feminine] pandemic, providing additional insurance against the lingering risk of very poor economic outcomes. The BPP ultimately involved the purchase of a total of $281 billion in Australian government, state and territory bonds between November 2020 and February 2022.
This review examines the BPP experience and draws some key lessons.
The key points are:
- The BPP, as well as the other monetary policy measures put in place during the COVID-19[feminine] pandemic, has contributed to the strong recovery of the Australian economy from the pandemic, with unemployment now at its lowest rate in nearly 50 years. Together, these measures further lowered Australia’s overall interest rate structure and bolstered confidence in the economy in the face of serious downside risks. Given the reinforcing nature of the policy measures and the fact that the BPP was a new policy tool that works through different channels, it is difficult to isolate the specific effect of the BPP on the economy. A key benefit of the policy package was to provide insurance against the severe downside risks the economy faced during the pandemic.
- The BPP is believed to have lowered government bond yields, but somewhat less than international studies generally suggest for a program of this size. This reflects the fact that the BPP was introduced at a time when other policy measures were already sending strong signals about future policy and bond market conditions were no longer tight, so liquidity premia were low. The Bank’s past bond purchases have helped restore the smooth functioning of government bond markets, which were under considerable stress at the onset of the pandemic. These purchases were made on an as-needed basis to support the market function (with no amount or timing specified) and were not part of the BPP considered in this review.
- Consistent with international experience, the effect of the BPP on government bond yields occurred at the time of the initial BPP announcement, reflecting the forward-looking nature of financial market participants. The reduction in government bond yields contributed to lower borrowing costs across the economy and a weaker exchange rate than otherwise, at a time when the spot rate was believed to be at its effective lower limit. International studies highlight the importance for central banks to act decisively when policy rates are close to the effective lower limit.
- The BPP has affected the public sector balance sheet in several ways. For the RBA, the bonds purchased pay a fixed return, while the interest paid on the exchange settlement balances (ES) created to pay the bonds varies according to monetary policy settings. As interest rates rise, there is a financial cost to the RBA. The ultimate cost will not be known until the last of the purchased bonds matures in 2033, with various scenarios presented in this review. In most scenarios, the Bank will not be able to pay dividends to the government for several years.
- For the broader public sector balance sheet, there are offsetting financial benefits. The higher growth and inflation resulting from the monetary policy package will add to the seigniorage the Bank receives from the issuance of banknotes. The reduction in yields has also reduced the cost of issuing public debt, and stronger economic activity than otherwise has increased tax revenues and reduced public support payments. Moreover, the debt-to-GDP ratio is lower than otherwise due to the revival of nominal economic activity. These benefits for public finances are important, even if they are difficult to quantify.
- The design and implementation of the BPP has generally worked as intended, without materially affecting the functioning of the market. The flexibility built into the BPP allowed for purchase adjustments in response to market conditions, thereby reducing the risk of compromising market functioning. In addition, the relatively short deadlines for each of the various stages of the BPP to which the Board has committed facilitated a quick and relatively smooth completion of the purchases under the BPP. These are important features to consider in the design of any future bond buying program.
- The Board’s communication of considerations for BPP adjustments prior to decision points, which themselves predated implementation dates, avoided unnecessary and disruptive adjustment as bond purchases were reduced.
- As set out in the performance objective review (RBA 2022), in light of the experience of the policies adopted in response to the pandemic, the Board of Directors has agreed to strengthen the way in which it considers a wide range of scenarios when making monetary policy decisions in the future. , especially when they involve unconventional political measures. With respect to any future BPP, this scenario analysis would include the potential benefits and costs of the policy, acknowledging the difficulties in measuring these outcomes.
- The Council remains of the view that the use of unconventional monetary policy tools should only be considered in extreme circumstances, when the usual monetary policy tool – the cash rate target – has been used. as much as possible. As noted in the review of the yield target, if the use of unconventional monetary policies was considered in the future, the Board did not rule out the use of a BPP or a yield target . Compared to a performance target, a BPP would provide more flexibility to respond to changing economic circumstances. However, a BPP could entail greater financial costs than a performance target, which should be carefully considered under the circumstances.
The exam is structured as follows. Section 1 provides an overview of the BPP and key decision points. Section 2 explores in more detail the deliberations behind the various decisions. Section 3 examines the effect of the BPP on government bond yields and the exchange rate, as well as its broader implications for the economy. Section 4 examines the financial implications of the BPP both for the Bank and for the overall government balance sheet. Section 5 assesses the BPP experience and draws some lessons.
Overview of the bond purchase program
On November 3, 2020, the Reserve Bank Board introduced a BPP as part of the second package of monetary policy measures implemented by the Bank in response to the COVID-19[feminine] pandemic. The BPP initially involved the purchase of $100 billion (face value) of government bonds with maturities of around 5–10 years. Purchases were made over six months at a rate of $5 billion per week, split 80/20 on nominal bonds (fixed rate coupon) issued by the Australian Government and by the States and Territories.
The BPP involved the purchase of a given quantity of government bonds in order to further lower yields at the 5–10 annual portion of the yield curve. This quantity target further down the yield curve was introduced to complement the three-year price-based yield target introduced in March 2020, as well as the long-standing target for the overnight cash rate, which constitutes the anchor point of the risk-free term structure. Government bonds are the benchmark fixed income securities in Australia, underpinning the risk-free interest rate embedded in the prices of most other assets. Together, this second package of monetary policy measures has been designed to further lower Australia’s overall interest rate structure and thereby support the economy by lowering borrowing costs, continuing to encourage offering credit (especially to businesses) and offering lower exchange rates than otherwise.
The BPP has been extended several times. In February 2021, the program was extended to incorporate the purchase of an additional $100 billion of government bonds from April to September 2021, at the same rate of $5 billion per week. In July 2021, the Council announced that purchases would continue beyond September 2021 until at least November 2021, but at a lower rate of $4 billion per week. In September 2021, the Council announced that purchases would continue at the rate of $4 billion per week until at least mid-February 2022.
In February 2022, the Board decided to cease purchases under the BPP. In May 2022, the Board of Directors announced that it did not plan to reinvest the Bank’s government bond holdings as they matured, nor did it have the intention to sell its assets.
By its completion, a total of $281 billion in government bonds had been purchased under the BPP – $224 billion issued by the Australian government and $57 billion issued by state and territory governments.
Originally published by the RBA