Policy actions during COVID
In mid-March 2020, as the impact of the virus and the health policy actions on the Australian economy became evident, the Reserve Bank Board put in place a comprehensive package at an unscheduled meeting to support jobs, incomes, and businesses, so that when the health crisis receded, the country was well placed to recover strongly. The package comprised:
- a reduction in the cash rate target (the policy interest rate) to 25 basis points, having already reduced the cash rate to 50 basis points at the earlier March Board meeting
- forward guidance that the Board 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 percent target band
- reducing the interest rate paid on Exchange Settlement (ES) balances (the balances the banking system holds with the RBA) to 10 basis points
- the introduction of a target on the 3-year Australian Government bond yield of around 25 basis points
- the purchase of bonds to address the dysfunction in the Australian government bond market
- a Term Funding Facility (TFF) for the banking system under which funds equivalent to 3 percent of lending could be borrowed from the RBA for three years at 25 basis points (against eligible collateral) up until the end of September 2020. The TFF provided additional incentives to support lending to businesses, tiny and medium-sized businesses, the continued use of the RBA’s open market operations to ensure that the financial system had a high level of liquidity. The RBA had already expanded its liquidity provision before the mid-March Board meeting to address the growing dislocation in financial markets.
In September 2020, as the end-September deadline for the drawdown of funding under the TFF approach, the Board decided to expand the TFF to provide additional low-cost funding equivalent to 2 percent of lending in the banking system. It also decided to extend the drawdown period for this and the additional funding linked to business lending to June 2021.
In October, the Board changed its forward guidance to focus on actual outcomes for inflation rather than expected outcomes in guiding its future policy decisions. At the November 2020 Board meeting, the Board decided on a further package of measures to support the economy:
- a reduction in the cash rate target, the 3-year yield target, and the interest rate on new drawings under the TFF to 10 basis points, from the previous rate of 25 basis points
- a reduction in the interest rate on ES balances from 10 basis points to zero
- The introduction of a program of government bond purchases, focusing on the 5 to 10-year segment of the yield curve. The RBA would buy $100 billion of government bonds over the following six months in the secondary market, purchasing bonds issued by the Australian Government (AGS) as well as by the Australian states and territories (semis).
The Board took this decision assessed that Australia was facing a prolonged period of high unemployment and inflation was unlikely to return sustainably to the target range of 2–3 percent for at least three years.
In February 2021, to provide further support to the Australian economy as it recovered, the Board announced that it would purchase an additional $100 billion of government bonds after the first program was completed. Those purchases are underway now.
The policy actions taken to deliver low funding costs have had several complementary elements and have been mutually reinforcing in underpinning low-interest rates across the economy. Next, I will explain each of these actions in detail.
Policy rate reduction
The first policy action I will talk about is the reduction in the cash rate target. This has been the primary lever of monetary policy for more than three decades now. The effect of this reduction in the cash rate on financial markets and the economy have been similar to the experience over those three decades.
The reduction in the cash rate provides stimulus to the economy through several channels. When the cash rate is lowered, it reduces funding costs for the banking system, which in turn flows through to lower borrowing rates for households and businesses. These lower borrowing rates stimulate borrowing and economic activity. The lower cash rate also boosts the cash flow of existing borrowers. It supports asset prices, including housing prices, which increases household wealth and hence spending. In addition, it puts downward pressure on the Australian dollar, which is stimulatory for the economy.