In November 2020, the Reserve Bank Board introduced a bond purchase program (BPP) as part of a second package of monetary policy measures designed to lower the structure of interest rates in Australia. This package was implemented to provide additional support to job creation and the recovery of the Australian economy from the COVID-19 pandemic, thereby providing extra insurance against the ongoing risk of very bad economic outcomes. The BPP ultimately involved the purchase of a total of $281 billion of Australian, state and territory government bonds between November 2020 and February 2022.
This review examines the experience with the BPP and draws some key lessons.
The key points are:
- The BPP, together with the other monetary policy measures put in place during the COVID-19 pandemic, contributed to the strong recovery of the Australian economy from the pandemic, with unemployment now at its lowest rate in almost 50 years. Together, these measures further lowered the whole structure of interest rates in Australia, and supported 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 package of policy measures was to provide insurance against the serious downside risks the economy was facing during the pandemic.
- The BPP is estimated to have lowered government bond yields, but by somewhat less than generally suggested by international studies for a program of this size. This reflects the fact that the BPP was introduced at a time when other policy measures were already providing strong signals about future policy and bond market conditions were no longer strained so liquidity premia were low. The Bank’s earlier bond purchases helped to restore good function in government bond markets, which were under considerable strain at the onset of the pandemic. These purchases were conducted as required to support market function (with no specified amount or timing) 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 around the time of the initial announcement of the BPP, 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 lower exchange rate than otherwise, at a time when the cash rate was judged to be at its effective lower bound. International studies highlight the importance of central banks acting decisively when policy rates are near the effective lower bound.
- The BPP has affected the public sector balance sheet in several ways. For the RBA, the purchased bonds pay a fixed return, while the interest paid on the Exchange Settlement (ES) balances created to pay for the bonds varies with monetary policy settings. As interest rates increase there is a financial cost to the RBA from this. The ultimate cost will be known only once the last of the purchased bonds matures in 2033, with various scenarios presented in this review. Under most scenarios, the Bank will not be in a position to pay dividends to the government for a number of years.
- For the broader public sector balance sheet there are offsetting financial benefits. The stronger growth and inflation as a result of the package of monetary policy measures will add to the seigniorage the Bank receives from issuing banknotes. The reduction in yields also lowered the cost of government debt issuance, and stronger economic activity than otherwise has increased tax revenues and reduced government support payments. In addition, the debt-to-GDP ratio is lower than otherwise as a result of the boost to nominal economic activity. These benefits to government finances are material, although they are difficult to quantify.
- The design and implementation of the BPP worked broadly as intended, without materially affecting market functioning. The flexibility built into the BPP allowed for adjustments in purchases in response to market conditions, thereby reducing the risk of compromising market functioning. Moreover, the fairly short timeframes of each of the various stages of the BPP to which the Board committed facilitated a timely and relatively smooth end to purchases under the BPP. These are important features to consider in the design of any future bond purchase program.
- The Board’s communication of the considerations around adjustments to the BPP prior to the decision points, which were themselves before the implementation dates, helped to avoid an unhelpful, disruptive adjustment as bond purchases were wound down.
- As noted in the Review of the Yield Target (RBA 2022), in light of the experience of policies adopted in response to the pandemic, the Board has agreed to strengthen the way it considers a wide range of scenarios when making monetary policy decisions in future, especially where they involve unconventional policy measures. In relation to any future BPP, this scenario analysis would include the benefits and potential costs of the policy, recognising the difficulties in measuring these outcomes.
- The Board remains of the view that it is appropriate to consider use of unconventional monetary policy tools only in extreme circumstances, when the usual monetary policy tool – the cash rate target – has been employed to the full extent possible. As noted in the Review of the Yield Target, if the use of unconventional monetary policies was being considered in future, the Board has not ruled out the use of either a BPP or a yield target. Compared with a yield target, a BPP would provide more flexibility to respond to evolving economic circumstances. However, a BPP could entail larger financial costs than a yield target, which would need to be carefully considered in the circumstances.
The review is structured as follows. Section 1 provides an overview of the BPP and the main decision points. Section 2 explores the deliberations behind the various decisions in greater detail. Section 3 reviews the effect of the BPP on government bond yields and the exchange rate, and the broader implications of this for the economy. Section 4 considers the financial implications of the BPP for both the Bank and the broader government balance sheet. Section 5 assesses the BPP experience and draws some lessons.
Overview of the bond purchase program
On 3 November 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 pandemic. The BPP initially involved the purchase of $100 billion (face value) of government bonds of maturities of around 5–10 years. Purchases were made over six months at a pace of $5 billion per week, split 80/20 across nominal (fixed-rate coupon) bonds issued by the Australian Government, and by the states and territories.
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The BPP involved purchasing a given quantity of government bonds in order to further lower yields at the 5–10 year part of the yield curve. This quantity target further out the yield curve was introduced to complement the price-based, three-year yield target introduced in March 2020, along with the longstanding overnight cash rate target, which forms the anchor point for 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 for most other assets. In combination, this second package of monetary policy measures was designed to further lower the whole structure of interest rates in Australia and thereby support the economy by lowering borrowing costs, continuing to encourage the supply of credit (especially to businesses) and delivering a lower exchange rate than otherwise.
The BPP was extended several times. In February 2021, the program was extended to incorporate the purchase of a further $100 billion of government bonds from April to September 2021, at the same pace of $5 billion per week. In July 2021, the Board 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 Board announced 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 announced that it did not plan to reinvest the Bank’s government bond holdings as they matured, nor did it have plans to sell its holdings.
Upon its completion, a total of $281 billion of government bonds had been purchased under the BPP – $224 billion issued by the Australian Government and $57 billion issued by the state and territory governments.
Originally published by the RBA