2: Quantitative Easing. Making You Feel Wealthy

Podcast Transcript

Quantitative Easing - Making You Wealthy

Nov 2021

David Plank - Head Of Economics - ANZ Bank

Ross MacDowell: Hi everybody, thanks for joining me for the Burgernomics podcast, where my expert guest use a hamburger to demystify economic topics that affect your daily life. Today, we are going to demystify that completely mysterious topic of quantitative easing. You've heard the term quantitative easing or QE for short mention countless [00:02:00] times through the media and many of you are none the wise or what it actually is.

Today we'll talk about who decides we need quantitative easing and why? What are the actual steps taken to create quantitative easing? What are the desired effects of quantitative easing? Are there any bad side effects of quantitative easing? Then we're going to apply the demystified version of quantitative easing to the [00:02:30] effects of the hamburger that you buy from your favorite store. To demystify quantitative easing my expert today is the guru of all economists at the ANZ bank. The banks head of economics himself, Mr. David Plank. David runs a team of Australia's brightest economist who advise on the ANZS more than one trillion dollars of assets. If there is anyone that can demystify [00:03:00] quantitative easing and then apply its effects to a hamburger it's David. David, welcome to Burgernomics.

David Plank: Thank you for that Ross for that very kind introduction.

Ross MacDowell: Now, David, if I've ever heard of phrase that explains absolutely zero about what it means it's the term quantitative easing. Most people hear it and switch off because they have no idea what it means. Where does the term [00:03:30] come from? And what's it actually meant to describe?

David Plank: So what, what it, the term itself was, uh, coined by a Germany academic in the 90s. And, um, at the time he was, uh, looking at Japan and, and, and arguing, what could they do next to get out of, um, uh, the deflation they were in or periods of very low inflation. And they'd already cut interest rates to zero essentially and so he thought one [00:04:00] thing they could do was, um, he coined the quantitative, quantitative easing. By that, what he meant was, uh, the central bank going out and buying a quantity of government bonds or other assets. And the, the idea was that and so doing they would put more liquidity or cash money into the system, and that would have, you know, know a positive impact on economic growth over time and therefore flow through eventually to an inflation.

David Plank: And, and, and [00:04:30] it refers to the purchases of other assets by the central banks.

Ross MacDowell: So it, what's, what was the point of it? What, what do they hope to a achieve by, by doing this?

David Plank: So it's really what, when central banks, you know, the, the, the, the main mechanism that central banks have historically used to manage the business cycle and to try and, [00:05:00] uh, boost the economy when growth is too weak and to restrain the economy or, or to lessen growth when things are too growing too quickly. Um, and the ultimate objective of the central bank is to, uh, target inflation. The, the main tool that we are using-

David Plank: At very recently that is has been interest rates.

David Plank: Right. And so the uh, central bank sets the [00:05:30] other interest rates in the economy. But when interest rates are really low, when they get to zero, what do you do next? Now, some central banks have got negative, but central banks have looking around for other tools and this has been suggested as one other tool. Where they can have another influence on the economy by directly purchasing um, other assets.

Ross MacDowell: Okay. So central banks for those people that don't, aren't able to differentiate what a central bank is a, central bank is the bank of the government. It's [00:06:00] not a bank that you and I can put our money per se. They're not in the, the shopping center. It's the bank that sets interest rates and it's meant to be independent upon the government. Is that, I got that, right?

David Plank: Yeah. The independence is a relatively new thing. I mean, the, I mean, central banks, like the art Reserve Bank of Australia, Reserve Bank of New Zealand, like you say, government entities, um, and really [00:06:30] independence of, of their ability to make the decision really only came about in the late 80s, on the 80s, into the early 90s, it became a, um, more and more, um, popular to do that.

Um, before the early 90 in Australia's case, you know, the, the treasurer hunt had a big say in what interest rates might be. And in setting interest rates, the only interest rate that they can control directly is the cash rate. Um, so longer term interest [00:07:00] rates, uh, are driven by the market, but of course, what the RBA or the central bank does for the, the cash rate, the overnight rate has some influence on longer term rates as well.

Ross MacDowell: Okay. So people's mortgages that's really determined by what you're calling the cash rate?

David Plank: In Australia yes. The, the cash rate that the RBA sets is an important part of [00:07:30] where mortgage rates. It's not the only part, because what ultimately sets mortgage rates is the cost of capital for banks like ANZ or CBA or NA. And that the cost of our borrowing is related to the cash rate but only relate. Um, we borrow from the market and from households, you know, deposit rates and so on. And depending on our credit rating, what's happening in other, you know, what's happening to global interest rates. There are lots of influences on [00:08:00] interest rates, but the RBAs can cash rate is the most important, uh, for mortgage rates in a country like Australia where most mortgages are inflating rates. So they're set off the, the cash rate or, or they're influenced by where short term interest rates are rather than long term interest rates.

Ross MacDowell: Okay. So you, you're describing a situation where uh, central bank sets this cash rate, which influences a whole lot of things, but [00:08:30] mortgages being the most important one for the mums and dads of Australia.

David Plank: Yes.

Ross MacDowell: And, and that cash rate got so low because of circumstances may be the global financial crisis that you couldn't keep on lowering it. It was nowhere to go other than zero or negative territory. So if the economy got into trouble or there was another GFC there was [00:09:00] no lever if you like left then to be able to boost economic activity. So they've come up with this concept called quantitative easing. Is that basically where we are at?

David Plank: That's it, that's it precisely. So yes, the cash rate they ran out of room. You can take the interest rates, negative some countries have done that. The Reserve Bank of Australia has said that it doesn't think it's a good idea. There are pros [00:09:30] and cons about doing that. But even if you thought you could take interest rates negative, there is a limit to how negative you can take them. Because then people will take the money out of banks and just have cash. Um, and so quantitative easing is another one of the tools that central banks have, have looked for as they've run out of room to use their traditional instrument of the, of the cash rate.

Ross MacDowell: So if, if they were to go to a negative cash rate, which you've said has happened in some countries, [00:10:00] does that mean that you would look at your bank statement every month? And if you'd put in a $1000 at the end of the month, because there's negative interest rates, the bank would actually give you a balance less than a $1000?

David Plank: So, you know, the cash rate would have to go quite a bit below zero for, um, interest rates paid to households to go [00:10:30] negative. But yes, I mean that in some countries there are negative interest rates. So if you leave exactly that, if you leave a $1000 at the bank at the end of the month, you get 990 something back.

Ross MacDowell: Okay.

David Plank: So yes, you get less back than, uh, you gave the, the bank.

Ross MacDowell: So you'd be basically leaving a $1000 in the account for the reason that it would be safe. In other words, the economy is that tense. Um, there, there could be bigger problems around the [00:11:00] corner you'd be happy to pay the bank, some of your money just to ensure a lot more of it didn't disappear.

David Plank: Yeah. That's why people would put up with negative rates. Of course, what the, what the, the central banks hoping you do, um, as interest rates for to low levels or go negative is that you'll take that money and buy something with it.

Ross MacDowell: Okay.

David Plank: And whether that's, um, whether that's a car or you, you know, you spend it on consumer goods or whether you go out and buy other assets-

David Plank: Um, what, they're, what they're trying to do by lowering interest rates, whether they're still positive or actually go negative.

David Plank: The whole purpose of that is to encourage you to spend more on something.

David Plank: And if you spend more on, on consumer goods, obviously you drive economic growth. If you spend more, if you buy another asset, you buy a house or you buy equities and you push up the prices of that-

David Plank: That creates what we call a wealth effect which makes people feel wealthier and then leads to more spending again.

Ross MacDowell: We'll get to that at the end, before we get to the, [00:12:00] the famous hamburger test, David. Now let's just run through the process of quantitative easing. So you've said to me that it, that it's basically the Reserve Bank of Australia it's a bond buying program. What's a bond?

David Plank: So a bond is a promise by the person that issued the bond. Uh, it's, it's, it is how it's how, [00:12:30] uh, governments and how lots of, um, corporations and banks and so on borrow. So what, um, you know, a household, somebody like you and I, we borrow by going to a bank and asking them to lend us some money and then we pay interest. What the, what the government does is it goes out into the market and issues a bond and says, "Here's a, a bond worth 1000 you know, with a face value of a $1000.

Ross MacDowell: Mm-hmm (affirmative).

David Plank: So if you buy this bond, I [00:13:00] will pay back, I will give you a $1000 in however many years time, however long the bond is.

David Plank: When that bond matures but I will also pay you an interest rate, a coupon-

David Plank: Of whatever rate three percent whatever the rate is are every six months for the lifetime of that bond. And then the government sells those bonds. And so the government won't necessarily get the face value it's a company I'm not going to, I won't go into the dynamics [00:13:30] of the pricing bonds.

Ross MacDowell: Yes.

David Plank: But there's a market for bonds. And so-

David Plank: The market will say, "Okay, we'll pay you the government X amount of dollars for that bond and that string of interest rates." And then the government gets the cash, which you can then spend on things and then it has this commitment to pay interest. And then the principle, this, the bond value back to the person that borrowed the money from it at the end of the life of the bond.

Ross MacDowell: Also there's a certain date that the money has to be repaid [00:14:00] back.

David Plank: Yes, yes. For most, for most bonds, there are bonds, not very many, but there are bonds that are called perpetual bonds where there's no requirement to pay them back.

David Plank: But then you just pay them, have an interest rate forever.

Ross MacDowell: Okay.

David Plank: But yes, there's, you know, the government has nearly a trillion dollars in debt at the moment. Um, and that debt is in the form of bonds that it's issued over the last few years. And those bonds can be six month, one year, two year, five year there's, [00:14:30] 40 year bonds out there. So the government owns bonds that don't mature for 30 or 40 years.

Ross MacDowell: Okay. So it's the reserve bank they decide we're going to have this concept called quantitative easing and they're going to do it by buying bonds. And at the moment that they're buying five billion dollars worth of these bonds every week. So if they're buying the bonds [00:15:00] who's issuing the bonds?

David Plank: So in terms of, you know, the quantitative easing, the, the, quantitative bit in the QE is that commitment by the RBA to buy five billion of bonds per week. So that's what they're doing there. They've gone out and set out a quantity of bonds.

David Plank: That they're buying. Um, and, and it happens to be five billion a week at the moment. So what they're doing is they're buy what that five billion, four billion is, [00:15:30] uh, spending bonds on buying Commonwealth government bonds.

Ross MacDowell: Okay.

David Plank: Like federal government bonds.

David Plank: Like Commonwealth government's issued. And another billion is buying bonds that the semi governments, the state governments like New South Wales, Queensland, Victoria have issued. So they're buying government bonds, but in Australia, there's bonds both from the federal government and the state government. So the RBA is buying four billion of Commonwealth in one billion of, uh, state bonds.

David Plank: Those bonds already exist. Those bonds have been issued [00:16:00] whenever.

David Plank: Uh, in some cases, those bonds have were issued years ago. But those bonds are currently owned by investors and banks and so on. And so the RBA is buying the bonds from banks.

Ross MacDowell: Okay.

David Plank: So it's the banks that will sell and the banks get those bonds. Uh, they either hold them for regulatory purposes or they, the banks themselves have bought those bonds off investors or other people.

Ross MacDowell: Okay. Now as, and correct me if wrong as I [00:16:30] understand it so the, the RBA have got this commitment to buy this enormous amount of bonds every week, every month. And it's the, what they call the office of financial management that create the bonds that the RBA are going to eventually buy.

David Plank: Yes.

Ross MacDowell: And so what, what happens does someone ring up the office of financial management and say, " [00:17:00] Hey, Barry, we need four billion dollars worth of bonds to auction this week. Um, can you put some ink in the printer please and, and punch a few out so that we can have an auction and then they print up, you know, however many pieces of a four paper is required. And then they have an auction for these bonds and the, and is the auction like a house auction? I mean, the, the banks and the financial institutions, [00:17:30] what do they all front up? And people put their hands like, like they would trying to a house to bid up the bonds. How does that work?

David Plank: So the decision to issue bonds is completely separate from the decision by the RBA to buy bonds. Um, there's a, there's a little area of uh, growing area of economic theory called Modern Monetary Theory, which, um, takes a whole different take on like that. But let's, let's not talk about [00:18:00] that at the moment. Um, but as things stand, I mean, the government, the, the, the Australian office of financial management, the RFM which is part of the treasury, uh, you know, I'm part of the government. They issue bonds regulation bonds every week.

David Plank: And they've been doing that for years and they do it regardless of what the RBA does. And the, and the amount of bonds that they issue is determined by, uh, the size of the deficit. So in the last couple of years, with [00:18:30] very, very big deficits, obviously because of, uh, the pandemic and government policies, the RFM has been issuing, you know, tens of billions of bonds every month. But that's a separate decision that they, the RFM announces it's, um, plans soon after the budget.

And then again, after the midyear and economic fiscal outlook, which comes in most likely in December. So a couple of times a year, the RFM says we're going to do this for the next six months. And then every week they announce [00:19:00] the details about what they're going to issue. And so there are lots of bonds out there. Those there's hundreds of billions of bonds out there, and the state, and the state governments do the same. The state government treasures they, they're group bodies that, uh, are responsible for managing their debt needs do the same.

They set out a, a, a process of issuing debt and that debt gets issued into the market and investors and banks. And by that debt as it comes out.

Ross MacDowell: Okay.

David Plank: The RBAs process [00:19:30] of QE of going out to buy bonds is completely separate. And the RBA just buys bonds that are already existing.

Ross MacDowell: Okay.

David Plank: In terms of how does the RFM get its dead out there? It stays well, this week we're going to issue two billion of bonds and it just creates an auction and people submit a price to buy those bonds. And then RFM gives the bonds to the investors that offered the highest price for those bonds.

Ross MacDowell: So the investors [crosstalk 00:20:00] [00:20:00] that are offering the highest price for the bonds, they wanna buy the bonds because they believe they're going to make some money out of the bonds. Either through the interest that the bonds pay along the way along the life of the bond, or because the bonds are tradable and they might be able to sell them for a profit. Is that basically it?

David Plank: Yes, that's right.

Ross MacDowell: Okay.

David Plank: That's right. So in Australia, the banks, the banks have to own bonds for regulatory reasons [00:20:30] because bonds are seen as a safe and investment. And so banks have to have some of their capital allocated to safe investments. If you like so the banks buy some of the bonds um, but then the rest are bought by, uh, investors and, and superannuation funds in Australia they'll own bonds and in foreigners, we buy them as well. About half of the government bonds on issue in Australia are owned by foreigners.

And they buy them because they want exposure to the Aussie dollar or they, they like the interest rate [00:21:00] that's being paid. Or like you say, they, they see an opportunity for the, the value of those bonds to go up. And so, you know, the global investors, uh, whether that be global pension funds or global banks or, or global central banks or sovereign wealth funds, there's lots and lots of global investors who buy bonds. And the bond market is huge. The bond market is much, much, much bigger than the equity market.

Ross MacDowell: Right?

David Plank: Most people don't realize that, that's not true in Australia, [00:21:30] but globally the debt market, the global debt market, which includes government bonds, corporate bonds, lots of different types of bonds is much, much bigger than the equity market.

Ross MacDowell: So what we've got as a situation where we've got the office the financial management, which is a group of people that are basically financing anything the government requires money for. Whether it [00:22:00] be a liberal government or a labor government, whatever government requires money to run the country and the reserve bank needs money to, for its operations or to alter global activity, um, not global activity, uh, Australian activity. And so this is the, the place where they go, they go, here we go. Office of financial management, please auction some bonds this week and this is what we need to run the country.

David Plank: [00:22:30] Sort of yes. Yeah. In a, in a, in a simple way I mean, the, the government makes its decisions about tax, um, what tax rates are and, and spending decisions. And then out of that falls a deficit or a surplus. And then that the, a RFM goes away and funds that deficit or surplus.

Ross MacDowell: Okay.

David Plank: The RBA has nothing to do with it. The RBA doesn't, the RBA can create money itself. So, um, it doesn't need money [00:23:00] from the, a RFM. It did get a capital injection from the government back in 2013. Uh, but technically the, the RBA can create it's own um, money through the, through general entry really.

Ross MacDowell: So the banks have bought all of these bonds for quantitative easing, currently five billion dollars a week, the banks and, and other financial institutions. The [00:23:30] money received from that auction presumably gets sent to the, the treasury. Am I right saying that?

David Plank: It goes into a government bank account. Yes.

Ross MacDowell: Okay. So it goes into a government bank account. The banks, the holders of the bonds, or the holders of these pieces of paper, which are IUs, basically have got them. They're getting some money for them along the way, in terms of interest. And then the reserve bank comes [00:24:00] along as part of their quantitative easing program and says, "Okay, we're going to buy, buy five billion dollars of these bonds back from you people per week." So you've, you've paid money to the Office of Financial Management to own these bonds. You've got them now that are on your desk. Now we're going to buy them back from you. Why would the banks wanna sell the bonds to the reserve [00:24:30] bank?

David Plank: Because the, the reserve bank is, is, is doing a quantitative easing. So that reserve bank is committing to buy those bonds regardless of the price. So the reserve bank does, what's called a reverse auction, which is where they state that they're going to buy bonds and then banks offer to sell them. And the RBA then, and, and the banks will offer to sell those bonds at a particular price. So a bank, [00:25:00] bank a might go to the RBA and go, okay, we'll sell you a hundred million bonds, but we want this price. And the RBA, because they made a commitment to buy five billion of bonds will, will then try to find that five billion of bonds at the lowest price that can. But that price might still be above where those banks originally bought the bonds from. So they could, the banks might make a gain on that or might not I mean, that depends who knows. Um, [crosstalk 00:25:28]

Ross MacDowell: So the banks have basically [00:25:30] got something that they like all of us. They wanna buy it as inexpensively as possible and sell it as expensively as possible to make a profit that's that's the basis there of our system.

David Plank: Yes.

David Plank: There's lots of turn I mean the turnover in the bond market is enormous. So there's billions and billions of bonds exchanging hands every day.

David Plank: So, you know it's hard to, [00:26:00] you know, the money trail, the money trail is not as linear as, as, as you might think it is. Because-

Ross MacDowell: Okay, I get it.

David Plank: The bonds might have changed it 20 times before we go back [inaudible 00:26:11].

Ross MacDowell: What we've got here is we've got one government department s-selling something in another government department buying it. It's kind of like selling your own car back to yourself in some ways. So is it the, is [00:26:30] it the profit margin on to the banks and the other people that have bought the bonds? Is that the real quantitative easing?

David Plank: I mean, the point you made about, you know, one arm of government doing something and then the other arm doing the reverse, that's where the Modern Monetary Theory people come in MMT and they say, well, why, why, why not cut out the middle men. And just give the, get the RBA [00:27:00] to give the money to the, the government. Um, there's the main reason we don't do that is around the, um, credibility, credibility of monetary policy.

If you had the central bank directly fund- funding, the government with kind of no step in between, which is that, and the step that the critical step in between is that the RBA makes the decision about whether to do QE or not, not the government. Uh, the [00:27:30] concern would be that if you got rid of that step and the government just funded itself, you end up with the, you know, all the stories around hyperinflation and so on.

And, and I think, um, you know, how, how re- how realistic that concerns us depends on the politics. The reason that central banks were given independence back in the 80s and 90s progressively was because the politicians decided that they couldn't be trusted to run monetary policy, and that, that had real costs. [00:28:00] And so it was better to make central banks independent.

So I think going back the other way is a big step, but, um, the quantitative easing is that by the RBA announcing, and it's the announcement effect as much as the actual, um, doing that matters. The, by the RBA announcing and then buying the bonds, it's flooding the system with cash. And that cash has several effects, that cash pushes down a whole bunch of interest rates. [00:28:30] There's more cash in the system, for instance, the RBAs cash target, its target cash rate is 0.1, but the actual cash rate is closer to zero.

So the actual cash rate is below the RBAs official target. And the reason for that is because of QE, QE has put so much cash into the system that, that cash is pushed down the actual cash rate to almost zero. So that's one effect and that flows through into mortgage rates. [00:29:00] Um, the other thing is, is that by saying, it's going to do QE and then doing it, it pushes down interest rates across the can. So longer team interest rates have also gone down, um, and that flows through into fixed mortgage rates.

So if you look at fixed mortgage rates in Australia, they've fallen much further than floating mortgage rates. And in fact, fixed rates are now below floating rates, um, which is unusual in Australia. And that's got, got a lot to do [00:29:30] with QE. So QE has had the effect of pushing interest rates down by a lot more than they would've fallen without QE.

The other thing it's done is there's a competitive global game going on here. Most central banks around the world are doing QE of some form or another. If the RBA last year, when the RBA, uh, started off doing its unconventional policy, it didn't do QE. What that means is that Australian [00:30:00] interest rate it's rose relative to global interest rates, they're put upward pressure on our exchange rate. [crosstalk 00:30:05].

Ross MacDowell: Okay, hang on just explain, just explain that, explain why you don't want our exchange rate to go up.

David Plank: Well, maybe you do actually. I mean, there's a lot of evidence to just that up over the long run having a strong exchange rate, um, is a good thing rather than a bad thing. But, uh, but when you're in a, in an economic slump and you wanna boost growth, [00:30:30] if the exchange rate goes up, it makes Australian goods more expensive. And so foreigners will buy less. Um, Australians will buy more imports than they will buy domestic goods. So if the exchange rate goes down, it makes your, uh, goods and services more competitive relative to other countries.

So it's generally seen at least for a short term anyway, as a good thing to push your exchange rate down. Of course, every country in the world's trying [00:31:00] to do the same thing. So, um, the is a limit to what they, what, what can happen there. But, uh, last year when the RBA didn't do QE and other banks, other countries were the Aussie dollar went up.

And a good example was that if that is the Australian dollar against New Zealand. So New Zealand was doing, the Reserve bank of New Zealand it was doing QE in quite large size, the RBA wasn't Australia wasn't and the Australian dollar went up [00:31:30] against the New Zealand dollar quite a bit. And one of the reasons I think was because we weren't doing QE. So when the RBA announced that it would do QE, one of the reasons it pointed to, to do QE was to, um, put some downward pressure on the exchange rate.

Ross MacDowell: Okay. So in, in terms of quantitative easing, we, we wanted to affect interest rates [00:32:00] but longer term, we wanna have higher interest rates because it gives our reserve bank an ability to lower them again in case there's another economic shock. So w- as an objective quantitative easing is one of them the inflation rate? They actually want there to be a high inflation rate?

David Plank: So the, the, [00:32:30] the objective of monetary policy, the RBAs objectives, uh, around inflation and employment, not around interest rates. So it doesn't have a view on interest rates per se. What it's trying to do is get the inflation outcomes, um, that it's mandated in its agreement with the government. So the government's told it that it needs to have and achieve inflation on average between two to three percent, and it hasn't done that for quite a while. And so what it's, and, and the reason for that is that seen [00:33:00] as the, as, as the inflation rate that will best contribute to the overall economic health of Australia, you don't want inflation too high.

David Plank: For lots of reasons. Um, and if inflation's too low, it causes another problem. [inaudible 00:33:14] two to three is and for Australia is seen as sort of the Goldilocks, um, level, not too hot, not too cold. Uh, and so the RBA, what the RBA is doing with all of its policy settings is trying to achieve that outcome.

David Plank: So what it's trying to do is, is ultimately get growth, uh, wages, unemployment to levels that it thinks are consistent with achieving two to three percent inflation.

Ross MacDowell: So we've got a situation implementing QE, trying to get inflation up, but what's happening is inflation seems to be a bit stubborn. So inflation's usually measured by the consumer price index, [00:34:00] you know, whatever the, the cost of groceries are. But lately what we've got is a situation where the inflation rate doesn't seem to really want to be shifting yet we've got other asset classes like people's homes, they're going through the roof.

The value of housing is going through the roof. So we sort of... Is there a disconnect here between the objective of inflation, which doesn't seem to be shifting. [00:34:30] But we've still got this QE program, the four billion dollar a week going on, and that seems to be affecting the housing market. So there's a sort of things aren't going up in unison. Could you explain that for us?

David Plank: Sure. So yeah could be. Uh, uh, the RBAs policy always has, um, different effects on different things. And, and one of, but one of the most powerful [00:35:00] drivers of market policy is through the housing in general. I mean, the RBA knows though sometimes it's a bit slow to recognize this. Knows that when interest rates fall house prices probably go up. So, uh, it's aware that, um, that cutting the cash rate will lead to lower mortgage rates.

And part of the process by which that supports the economy is through the housing market. And the RBA actually wants when it cuts interest rates, house prices to go up. Because that [00:35:30] supports consumer spending and makes households. Well so more people own homes than don't so even though it has, you know, negative effects on those who don't own houses, but, you know, the housing dream gets harder, more people own homes than not in Australia.

Um, so, you know, net, net or our house prices boosts growth. Uh, as well with quantitative easing one of the criticisms of quantitative easing globally has been that it creates [00:36:00] inequality because it boosts asset prices. So that's what, I mean again, that's what the central bank's trying to do is it's trying to lift growth. One of the channels is to boost asset prices, but those people who own assets benefit a lot more than those people who don't. So that's one of the criticisms of QE.

Of course, the alternative potentially is that if you don't do QE, you end with much higher unemployment, and there's nothing more inequitable than unemployment. So the central [00:36:30] banks would respond to that criticism of QE by saying, "Well, yeah we know that, um, QE, anything we do has different effects on different people. You know, if you're a, a pensioner with, um, lots of savings in the bank, then low interest rates are bad for you." Um, but, uh, we know ultimately the worst thing for inequality is unemployment. So-

David Plank: We can do whatever we can.

Ross MacDowell: Here in summary, what [00:37:00] you're saying is quantitative easing, the objective is get inflation up. So most of the goods and services in the economy cost more. And therefore we compensate for that by increasing people's wages. That's the, that's the fairy tale version but in effect, even if that's not happening and we've got certain asset classes being people's homes going up, and we've got full employment, [00:37:30] that's better than the alternative. So people are complaining, "I can't afford to buy a house." But it's better they complain about that and still have a job.

Ross MacDowell: Than, than not.

David Plank: That's right. And of course the other thing, you know, what the RBAs trying to do is boost the economy, therefore put downward pressure on unemployment that eventually lead to higher weight growth.

David Plank: And that higher weight growth to feed into inflation. So the RBAs [00:38:00] objective is ultimately to push up wages actually, that's what they're trying to do.

David Plank: And they, they know that the only way there'll be sus... Get higher inflation sustainably is to generate higher wage growth. So that's what they're trying to do. But some of their policies have other effects and one of them is house prices go up. And, uh, it's possible to have, if you like too much of a good thing and, and higher house prices, higher equities. You know, the higher share prices and so on have [00:38:30] equity effects. But you're right I think, uh, if the RBA didn't do any of that and unemployment was a lot higher as a consequence, that would be a worse out then.

Ross MacDowell: Now some people have said there could be an alternative to quantitative easing that if you, if you look at the amount of money that's being spent five billion dollars a week. Why bother to create this bond creation and buyback process? Why [00:39:00] not just give everybody a $4,000 tax credit or why not just put $153,85 cents into every single person's bank account?

David Plank: And, and effectively, I mean, you know, what the government's policies are that are being financed by the deficit w-was, was to do that. I mean, the government really decided through a lot of its policies to put more cash into people's hands. They did it through job keep and other measures, [00:39:30] but, you know, gave effectively gave money to households. Um, the mo-Modern Monetary Theory, MMT, which has become kind of trendy recently from the last few years, which say exactly that.

Let's, let's just give money to people directly. Let's take out the, the middle person, um, and not have the RBA deciding whether or not to buy the bonds. We'll just make the RBA will tell the RBA to buy the bonds. I would argue that, [00:40:00] um, and lots of other people would argue that the, the key part about keeping inflation under control over the long run and not having hyperinflation and not having, or even elevate, you know, inflation that's, you know, like Australian as you all had for a long period of time it was too high, is to keep the central bank independent.

And so what we end up with is what I would call a hybrid [00:40:30] of MMT. Yes, the central bank is funding the government. The RBA is funding the deficit by buying the bonds but it's making the choice. Uh, it's not leaving the choice up to the politicians. And so therefore it's removing that problem that we had 20 or 30 years ago. The reason we went to independent central banks was because governments increasingly realized that they couldn't trust themselves.

[00:41:00] That they would... You know, that if you wanna run fiscal policy in a way that doesn't generate higher inflation, you have to be prepared to, uh, pull back to increase taxes at time or cut spending. But there's always an incentive to, uh, cheat as it were, uh, you know, for political reasons. And so therefore you wanna create an independent body really, that can target inflation. And so that's what they did in the central [00:41:30] banks.

So that's why and I think the right way of doing it is the way we're doing it at the moment, which is that it's the RBA that makes the choice about whether or not to buy the government bonds. And so the government knows that the RBA might one day step back. So it can't get... You know, it's gotta make sure that its fiscal settings are credible because the RBA may not be there all the time.

Ross MacDowell: So is really what you are saying that [00:42:00] the money creation process which rests in this case with the banks that are the purchaser and the seller at a profit of these bonds. And then the banks, your bank, or the other banks, they have this money which is slightly more and then they have to put that money to work. And they put it to work via loans, whether it's for housing or for whatever. [00:42:30] And there's lending criteria to the, to the use of that money. Is what you are saying, the government really trust the banks and its lending criteria to create economic activity more than themselves, to be able to go out and start spending the money just by printing it.

David Plank: We do both. The government is spending an awesome amount of money. So it's, [00:43:00] uh, you know, lots of infrastructure been, you know, evolved. But, um, you know, there's a limit to what governments can do. You, you know, most economic activity is driven by individuals, not by the government and the government is responsible for about a quarter. Um, and then that in some countries a bit more. But a lot of what governments do is take money from one person can give it to another-

Ross MacDowell: Mm-hmm (affirmative).

David Plank: Transfer payment-

Ross MacDowell: Mm-hmm (affirmative).

David Plank: Which I don't have a problem with. That's part of living in a, a society as you want to help out those people who need help and, um, [00:43:30] free education also but, but you know those are the good things so. Um, so governments do a lot of that but um, private sector activity is the, is the bulk of what economies do. And so you want people to make decisions about whether to borrow or not.

What to do, whether this is a good business or not, you want governments to, uh, sorry, you want individuals to make those decisions. Businesses to make those decisions cause they have found the information than governments will ever do. Um, about whether or not a business is good and, and so you want them to make [00:44:00] the decisions. And so what happens is that, you know, QE, the banks wanna lend money out. Yes. And so they'll, and, and it's competitive.

And so they'll be chasing customers and then customers will respond to the incentives as interest rates go down a more, more, um, things that make sense to do cause of lower funding costs. And so there's this whole process of generating economic activity. And I don't think you want the government to do that cause governments [00:44:30] simply won't be able to direct what to do. Um, you know, that we've some countries that have tried that doesn't end very well really, uh, in terms of governments trying to direct too much of the economic activity.

Ross MacDowell: Because you get a hyperinflation, is that your?

David Plank: Well, I just don't think governments do a very good job and, and, and those micro decisions about whether to invest in, you know, in processes or things like, you know, all sorts of things. You know, who would've would, would government [00:45:00] have invented the iPhone? Probably not.

Ross MacDowell: Right. Okay. Now quantitative easing being a relatively recent economic lever to create activity from 2008, I think was the first time in terms of the Americans using it.

David Plank: Yeah. The Japanese started it in the early 2000s.

Ross MacDowell: So [00:45:30] for a couple of 100 years or even longer economies have gone up and down, troughs and peak. Share markets have had booms and bursts. Commodity markets gone up and down. Everybody seems to have been happy with the let's call it the natural rhythm of economies. Good times, bad times now we have quantitative easing, [00:46:00] is there not an appetite anymore by governments to endure the ups and downs? And it's almost like, no, we always must have things going better and better and better. And, and we must never have troughs or corrections or crashes or slumps. I-I-Is the thinking changing now and quantitative easing is the result of that changing thinking?

David Plank: Oh, I think the thinking changed in the 30s, in 30s. [00:46:30] So quantitative easing is just a, a, a consequence of the horrors of the depression and the conclusion that we would need it to do better, um, than allowing economies just have slumps where one third of people were outta work. So I think that was the, the game breaker. Um, and if you go back prior to the mind fears depression, then there are, there'd been other depressions, [00:47:00] there was the depression in the early 90s in Australia right.

So, um, and so over time we moved away from a gold standard because gold standards... The fixed money supply have those sorts of shocks. They, um, uh, and so I think, you know, as a consequence of the 1930s and, you know, cans in economic. Uh, the year that came out of the second world war with a view that we should manage the business [00:47:30] cycle better than we had in the past. Now there are some uh, and we did that pretty successfully in the 50s and 60s.

There were some inherent contradictions in what was happening in the sense that, um, that the, um, ability of governments to keep economies, uh, growing sort of above trends with our inflation, there was an inherent problem with that. And that was, [00:48:00] uh, came about in the late 60s, um, with, um, you know, uh, various people pointing out the difficulties of that and, and around full employment and, and so on.

And then we had, uh, no interest revolution in the 70s and 80s, and then, um... But really that, all of the stems from the, the view that we don't wanna repeat the great depression. And so when the GFC happens, Bernanke who was the chairman of the [00:48:30] US Feds, uh, when he was at the US Fed, not as chairman, um, in the early part of the 2000s when there was the take reconcile.

But his view and he gave a speech in, I think, 2003, um, about quantitative easing and about basically the lessons of the depression. And he was a scholar of depression that was one of the areas in his academic research that it was a, th-th-th-the great depression was largely a consequence, of the, of The Fed but [00:49:00] The Fed inappropriately tightened monetary costs. Now there's lots of arguments around that, but, um, uh, and so they wanted to avoid that.

And so when the, when the financial global financial crisis hit, uh, there was, you know, and that was, that caused the great recession. There was the fear and The Fed and Bernanke that you could get a great depression. And so you had to do whatever you took really to prevent that. And one of the things they decided to do was quantitative easing, [00:49:30] but it, it flowed from the 30s.

Now as a consequence of QE, uh, since 2008 and one of the issues is how you get out of you end up with QE forever or QE infinity. There has been various terms raised around it. And the point you've made about that, that, that we end up being star risk averse, that we don't allow the natural rhythm of to extent, there is a natural rhythm of maybe there isn't a [00:50:00] natural rhythm, maybe, maybe [inaudible 00:50:05]. But as we pointed out, you know, in a normal cycle, there will be firms that go to business but whose business model doesn't make sense.

If you stop that from happening, then ultimately that may be a bad thing that you may end up with much lower productivity growth. Cause you end up with lots of firms out there that are the so-called zombie firms that really shouldn't be there. [00:50:30] But that are t-taking up people's time that are employing people that would be better off doing something else.

Um, yes, the collapse of those firms is painful and, um, getting resources to transfer from an inefficient use to something more efficient. Doesn't involve somebody losing money and might involve people losing their jobs and that's real pain. But if you prevent that from happening, then you end up ultimately in a worse position, lower productivity, lower growth. So I think there is an, there is [00:51:00] that argument, I think has a lot of merit. The difficulty is, um, getting from A to B and clearly you don't want to get from A to B with unemployment at 35% as it got to in the US during the growth inflation. You wanna manage it if you can, better than that so it'll get through them.

Ross MacDowell: Okay.

David Plank: That is again, one of the criticism of QE.

Ross MacDowell: All right now, we get to the fun bit David. [00:51:30] We want you to apply quantitative easing. If it was to be implemented as the reserve bank, think it should be its effects on a hamburger. So from the point of view of the person buying the hamburger and the people making the hamburger. Just run through, if you wouldn't mind, you have quantitative easing, [00:52:00] the different effects how they run through for our hamburger.

David Plank: Yeah. So ultimately the objective of the reserve bank is to get more hamburgers out. So in the next simple term chronology, and to have more people making hamburgers. So there's more quite employed people employed doing hamburgers. Um, and so what they're trying to do is, um, by lowering interest rates and flushing the system [00:52:30] with, with liquidity, is people going, "Oh, I can actually, I've got, cause I'm paying less of my loan or other things I can buy another hamburger."

Now the supply of hamburgers is fixed at the moment. So the people's demand for hamburgers goes up. To get more hamburgers made you wanna put some upward pressure on him, on the price of hamburgers. So the people that supply hamburgers have an incentive to make more. Uh, and because the price [00:53:00] of hamburgers is going up a bit more, they, and they'll demand more beef and the farmers will respond to that by supplying more beef. And you'll get a combination of, um, but some additional buy hamburgers and some additional supply. And that's, that's, that's what you're trying to do.

Ross MacDowell: So the price of the hamburger rises immediately because our economic activity has gone up. People are, more people [00:53:30] are being employed cause we are closer to full employment and they-

David Plank: Doesn't happen immediately. This all takes time.

Ross MacDowell: It's it takes time. Okay. So

David Plank: The lag, they also say in monetary policy that the lag are long and variable, which means we they're long. We don't really know how long they're so [crosstalk 00:53:48].

Ross MacDowell: So we don't know how long after quantitative easing it's going to take for people to feel like they wanna buy more hamburgers.

David Plank: No, that's right. Could take a while or not-

Ross MacDowell: Okay.

David Plank: It depend.

Ross MacDowell: So [00:54:00] it takes a long time, perhaps let's say that. And then they go out and they start buying some more hamburgers. And as you've said, that number of hamburgers being made just the same. So we get a bit of inflation on hamburgers. The price of the hamburger goes up. Does that, does that cause the, the people that are buying the hamburgers, the, the, the newly employed workers to go back to their bosses and say, "Look, hang on. I need some more money here because [00:54:30] I'm buying some hamburgers cause of now I can cause I've got a job, but all of a sudden they've gone up in price. Could you compensate me for that?"

David Plank: Well, what I mean, that might be part of the process, but what you hope will happen is that the bosses need to make more hamburgers. So they need to employ more people and to encourage people to make hamburgers, rather to come and tell them to make hamburgers rather than something else than people's wages are. So wages rise because employers want more people in their shops.

And so what you've seen, if you look in the US, [00:55:00] um, recently, uh, places like Walmart and so on have, have raised their wages because it's harder for them to find the workers that they need. Even unskilled, relatively unskilled jobs, wages have been going up because unemployment's before. So those workers have been harder to find. So workers are harder to find but they want more of them cause demand of their products has gone up. They might have to pay them a bit more.

And then by paying them a bit more then, [00:55:30] and there's, there's a virtuous circle that you get going hopefully. By paying people a bit more that allows people to buy a bit more hamburgers and pay the highest, slightly higher prices. And then again, you create more... Um, so you're hoping that you create a virtuous circle there and that virtuous circle becomes self-sustaining and then eventually you don't need the cure cause you've kind of generated this activity.

Ross MacDowell: So we create a bit of acti- economic activity, people buy more hamburgers. [00:56:00] The hamburger goes up in price. The people making the hamburgers have to put the prices up because they're trying to produce the, the, the lettuce, the cheese, the, the bun, the beef patty. And it's a circle because when that production comes on board, they've gotta employ more people to do it. And those people will want to eat some hamburgers, even though they're making them. And then it just goes around in a circle.

David Plank: Well, that's the, the hope. Yes.

David Plank: The concern of course, is that you then withdraw the QE, you stop doing it and then everything slumps again. So that's always the tricky balancing act. Is knowing when you've generated enough of a cycle on its own, that you can start to step back. And the RBA in July announced that they would start to in September, start to reduce the amount of bonds that they buy.

Ross MacDowell: And is that-

David Plank: And of course without pep by Delta and [00:57:00] now there's conjecture that they might, uh, change their mind on that, but we'll see. We'll find out soon.

Ross MacDowell: So I've heard a term that when central banks talk about withdrawing quantitative easing, there's something that occurs called a, a tantrum, a, a temper tantrum.

David Plank: A taper.

Ross MacDowell: A taper tantrum.

David Plank: Taper tantrum.

Ross MacDowell: Tell me, tell me about a taper tantrum.

David Plank: So this refers [00:57:30] to, um, when Ben Bernanke, who started the QE by The Fed, he was the chairman of the US Fed started 2012, 13 talking about the, The Fed, the US Federal Reserve, um, which is the biggest, most important central bank, cause its controls the US dollar. Um, or control is that's too generous a word. It, um, influences US interest rates and the US dollar.

[00:58:00] Um, he started talking about the, that The Fed would start to reduce the amount of bond purchases it did. And that was a surprise to the market. And so the taper tantrum was you saw a spike at interest rates and you saw equity markets start to sell off. And so this is the issue that people often say is that once you've started QE, how do you get out of it? Because could into asset prices, equities and [00:58:30] commercial property and house prices is the expectation industry traits will stay low potentially forever or for a long period of time.

And if those expectations start to change because The Fed or the central bank says, "Actually we think we've done enough QE. We don't wanna do anymore or we're going to do less." If that then feeds through into interest rates, it starts affecting other things. And do central banks are they confident enough? And they're to put up with that kind of volatility [00:59:00] and or do they get spooked?

Do they see equity markets start to react negatively and they think, "Oh my God, I can't, I can't actually change until like." Um, and so that you end up with some people talking about the problem with QE. One way it's been put that I put it a while back, it's the hotel California problem. You can check in anytime you want, but you can never leave because it just gets built inside the system. And that's one of the complications. And so we don't know, no central bank is it, [00:59:30] um, successfully exited QE completely,

Ross MacDowell: Really. Not one yet.

David Plank: No.

Ross MacDowell: And as so the big fear that we could end up with those black and white photographs that all students were shown in economics 101 of the, of the young five year old child in, in Germany in 1930, going to buy a loaf of bread [01:00:00] with a wheelbarrow full of money. Hyperinflation, is that going to be the thing that'll eventually get central banks to stop creating money?

David Plank: Well I don't think there's much risk of that in, in, in countries with credible central banks, independent central banks, because they'll avoid that and they'll step back, you know? Well, before that happens I mean, what, you know, what you do hope is that they are successful. You know, the difficulty has been in generating [01:00:30] even more inflation. And so we've been stuck in a world, you know, for a long time now we're even generating a low rate of inflation it's been tough.

Now, maybe we are successful this time. Maybe with lots of fiscal policy and so on we're we're able to achieve, um, you know, moderate rate of inflation. And if we do that, then maybe central backs can step back. So I think, you know, we're a long way for worrying about hyperinflation. I mean, there're concerns that were initially delivered about QE. There were [01:01:00] lots of concerns around that people had that maybe that would lead to overshooting on inflation, getting much more inflation and we thought we would, and that never happened.

You know, there's lots of other things going on. So, uh, I'm not particularly worried about that risk, um, so long as central banks remain independent and credible. If we lost central bank independence and they got told to do what governments could tell them precisely what to do, then they might change. [01:01:30] Um, uh, and that's the problem in countries that do have hyperinflation is the central banks just get told what to do. Um, but, uh, yeah, I'm not, I don't think there's any real pro realistic prospect of that, um, in, as I said, in those places with credible central banks. The difficulty is getting any inflation, you know, getting it, you know, the RBA has been struggling to get inflation back to two, leave alone above three. So let's deal with that problem first.

Ross MacDowell: So, and you think QE is here for [01:02:00] quite a lot longer now?

David Plank: Well, I think QE is now just a general part of the toolkit for central banks. So QE will be with us for a long time. Um, it's not, you know, maybe the RBA can, uh, get on a program where it stops buying bonds for a period. But inevitably given how low interest rates are when we get hit by the next big shock, and shocks come along regularly, the next big shock it will have to do QE. [01:02:30] Because it will run it will quickly run out of room to cut infrastructure. So QE of some form is now part of the normal central bank toolkit.

Ross MacDowell: David, thank you so much for your time in joining us on the, the Burgernomics Podcast. You have de-packed and demystified quantitative easing for all of our listeners, for which I think they will be grateful for. Because [01:03:00] they become unties towards some of these economic terms that are thrown at them daily by the media. And are told that they're going to have a positive effect on their standard of living, but they don't know how or why. So you've explained to us not just QE but also the precise process of how it's created through the, the bond buying process. So thank you very much. I've enjoyed talking to you. It's, it's a fascinating journey just one area [01:03:30] and maybe we can join up again in the future.