How the Govt’s announced economic stimulus works

Today, (as at midday Friday 20 March), the Australian share market is trading up 4.24%. This is showing that investor confidence has risen in response to global governments and central banks taking action to ease the economic pain caused by COVID-19.

I thought I’d take the opportunity to explain what the components of the Australian economic stimulus package are and how they work.

Yesterday, the Reserve Bank of Australia (RBA) and the Federal Government both announced measures on to encourage lending to businesses and to boost demand in the Australian economy.

So, what are the emergency stimulus measures – and how will they impact households and businesses?

1. Official interest rate cut to 0.25%

On Wednesday, the RBA held a special meeting (out of its usual cycle) and decided to cut the cash rate to 0.25%. This is a new record low following a cut made just two weeks ago.

The RBA Governor, Phil Lowe, said the bank expects the official interest rate to remain at this level for three years.

“At its meeting, yesterday the board also agreed that we would not increase the cash rate from its current level until progress was made towards full employment and that we were confident that inflation will be sustainably between 2 and 3%,” he said.

“This means that we are likely to be at the current level of interest rates for an extended period of time.”

Lowe reiterated that 0.25% is rock bottom, there is no further to cut. “We’ve done all we can on the cash rate.”

2. Quantitative easing

The RBA has set a target for the yield on 3-year Australian government bonds of around 0.25%. It’s going to buy government bonds in the secondary market to achieve this.

Lowe flagged this in November as a last-resort option if interest rate cuts and fiscal stimulus weren’t enough to boost the economy.

Buying government bonds essentially creates new money, lowering the borrowing cost for the government and freeing up credit elsewhere in the system that can flow through to households and businesses that need loans to survive, or to make long-term investments that can stimulate the economy.

Lowe said the RBA is prepared to buy “whatever quantities are needed to achieve this objective” – so there are no limits on this aspect of the program.

3. Cheap credit to banks to lend to businesses

The RBA has set up a three-year funding facility for at least $90bn to be lent to authorised deposit-taking institutions (ADIs which are the banks) at a fixed rate of 0.25%.

Banks will be able to obtain initial funding of up to 3% of their existing outstanding credit, with more money on offer if they increase lending to business, especially to small and medium-sized businesses.

The aim is to encourage lending to businesses to spend and invest, keeping workers in jobs.

4. $15bn from the government for business lending

The Morrison government has chipped in “up to $15bn” to enable smaller lenders to continue supporting Australian consumers and small businesses.

While the RBA is looking to lend to authorised deposit-taking institutions, the Australian Office of Financial Management will skew the $15bn to smaller institutions and non-ADI lenders.

The Federal Treasurer, Josh Frydenberg, said the measure was designed to “enable customers of smaller lenders to continue to access affordable credit”.

5. Banks to get a boost for cash held with the RBA

The RBA will also increase the interest it pays on exchange settlement balances – essentially banks’ accounts with the RBA – from 0 to 0.10%.

“This will mitigate the cost to the banking system associated with the large increase in banks’ settlement balances at the Reserve Bank that will occur following these policy actions,” the RBA said.

6. RBA to help banks with poorly performing loans

The RBA currently undertakes one-month and three-month “repo operations” – in which it buys financial assets (mortgages, say) off banks, then sells them back in a few months’ time, to provide liquidity to Australian financial markets.

The RBA has announced it will continue doing this, and in addition it will now conduct longer-term repo operations of six-month maturity or longer at least weekly, as long as market conditions warrant.

Working together to get through this

What is so encouraging is to see the government and RBA work so closely and positively. We should feel further encouraged that similar actions are being rolled out across the world.

The markets are reacting positively today. We all know that may not be the case tomorrow. However, if governments and central banks continue down this path and continue to support the banking and business sectors it will undoubtedly lessen the negative effect on the global and Australian economies, reducing the impact of a recession, and speeding up a recovery that inevitably has to come.

If you would like to discuss this with me in more detail or have any questions please don’t hesitate to email or call me.