Mar 24, 2020 Politics
This morning the Reserve Bank announced it would be buying $30 billion worth of government bonds – an unprecedented move. But what does that actually mean? Metro digital editor Tess Nichol, once again, doesn’t know. So she asked her longsuffering father, Pattrick Smellie of BusinessDesk, to explain.
Tess: Let’s start with the basics – what’s a government bond?
Pattrick: Whatever happened to Hi Dad, Hi T?
Sorry – hi dad!
Ok now tell me the stuff please
Oh alright. A government bond is just a way the government borrows money. It can issue a ‘bond’ for, say, 15, 20, 25 years and agree to pay an interest rate for that. It’s like you making a loan to the government and they then use that money to to fund their spending
Who has the bond in the meantime? And who are they borrowing the money from?
They are basically borrowing money from banks, investment and pension funds and retail investors like you. The bondholders receive interest until the bond matures and then they receive their money back. They can also buy and sell the bond in the bond market, where the price goes up and down depending on where interest rates are.
It differs from just printing money in two ways. No money is being ‘printed’ as the government is taking already existing money from the market. What’s important and different today is that the Reserve Bank – the government’s central bank – is promising to buy those bonds rather than expecting banks/private sector investors to buy them. They plan to buy government bonds up to a value of $30 billion, which believe me, is huge. That’s partly because when the government tried to sell bonds last week in the normal way – on the open market – the interest rates were higher than normal because there were very few buyers. This reflects some of the nervousness and fragility that is starting to be seen in global financial markets at the moment simply because of the sheer size of the coronavirus challenge, both health-wise and as an economic problem.
In this case, the Reserve Bank is using central bank money, which is money they are creating. So, rather than the investors buying the government bonds, the Reserve Bank buys them, and this provides a huge pot of new money for the market to use. When the Reserve Bank buys those bonds it’s called ‘quantitative easing’.
What does having these bonds bought by the Reserve Bank actually mean? How does that stimulate or otherwise positively affect the economy?
They plan to buy government bonds on the secondary market and so keep interest rates low. Their thinking is that keeping interest rates low will encourage economic activity. This is what the major central banks did after the Global Financial Crisis. It doesn’t always work that well, especially when people are not in the mood to borrow or consume, or, can’t do much – like when the economy is shut down. Some commentators believe the Reserve Bank should be buying government bonds directly, rather than the government issuing new bonds into the market and then the Reserve Bank buying some of those. It’s a complex issue and NZ has no experience of doing this. Ultimately, it’s all about saving jobs and businesses.
The size of the coronavirus threat to economic activity is very large and, for the moment, fairly hard to be sure about. Just as it requires both a very powerful public health response, it needs a very powerful economic response because of the disruption to everything normal that flows from the health response (caused by the virus).
I’m very supportive of the Government, at a time like this, doing things that normally would make no sense at all – pumping new money into the economy to will be vital to allowing businesses that are facing possible failure to survive this and keep people’s jobs. It would seem like a massive overreaction in most other circumstances but this is a time when over-reaction is justified. Doing too little will cause economic harm that can be avoided.
Think of it this way: which is worse? A government debt blow-out that takes us a decade to get on top of? Or a massive round of business failures and job losses? I’ll take the debt, thanks. NZ is very well placed to deal with this because our government debt levels are quite low, thanks to prudent economic management for most of the last 30 years (in my view).
Ok I know you have to go but two more quick things – in really simple terms can you explain how that money ends up with businesses? Presumably, the idea is the money keeps businesses afloat, which keeps people employed, but how do bosses/ business owners get their hands on the money? I just can’t quite wrap my head around what it means.
The money gets to businesses through the banking system. It’s extremely important that the reaction of the banks to this flood of money is that they make it easily accessible to businesses. This money will make sure credit is available, there is plenty of it and its cheap.
I’m expecting we’ll see announcements on that from the major banks in coming days. They will have to take a far more lenient and sympathetic approach than they would normally to such lending. Government guarantees may be required to get them to that point. The reality is that not all jobs and businesses will survive this, no matter how much the government, Reserve Bank and banking sector adopt these measures. What is vital is that they adopt them swiftly, wholeheartedly, and without trying too hard to apply all – or any – of the normal rules.
These are unprecedented times, so unprecedented actions are warranted. As I say, this is what governments are for.
When you say more lenient, do you mean for e.g. offering loans with no interest, or something else?
I mean things like not requiring the owner of a business that faces Covid-19 disaster being required to put their family home up as a guarantee on new lending, suspending principal repayments on mortgages – the Aussie banks have just done a package like this and I expect the NZ banks will follow suit. We are experiencing a sharp, global shock to the whole economy, but one which will end, so government needs to underwrite the economy, whilst people work out what the real impact is going to be. For sure, some businesses won’t come back and the way we do business and live may change.
This is a very anxious time for a lot of people – got any reassuring fatherly words?
This will come to an end and people are remarkably good at adapting to new circumstances. I think the government is rising to the occasion, although even faster would be good. I think we will see a lot more action in the next few days.
New Zealand is in better economic shape than most countries and can weather this better than many, as a result. One thing that will be great is not having to endure my fellow Boomers’ social media posts about their exotic northern hemisphere holidays while I’m slogging it out at my desk in mid-winter.
Thanks Dad! Love you
Love you too.
?This article has been updated from when it was first published to clarify some of the more complicated points made.
Pattrick Smellie is a founder and business journalist at BusinessDesk, with more than 35 years’ experience in journalism and corporate public relations. He’s also Metro digital editor Tess Nichol’s dear old dad. You can subscribe to BusinessDesk for just $24 a month.