The Reserve Bank took official interest rates to an all-time low of 0.25 per cent in March to deal with the coronavirus recession, has bought $60 billion worth of state government debt and extended a $90 billion line of credit to commercial banks to on-sell to small and medium-sized businesses.
Dr Lowe, who confirmed the RBA was unlikely to embrace negative interest rates that have been put in place by some central banks, used the annual Anika Foundation address in Sydney to make clear that despite the growing interest in alternative monetary policy approaches, it would not be adopted by Australia.
He said the creation of money by the bank to finance a government’s debts, or dropping money to taxpayers from a helicopter, were defended by advocates as a way of avoiding traditional constraints on public finances.
But the idea that because central banks printed money meant they should do so without restraint ignored real impediments.
“The reality is there is no free lunch. The tab always has to be paid and it is paid out of taxes and government revenues in one form or another,” he said.
Dr Lowe said if a bank created money to be spent by a government, that money would be a liability on the bank’s balance sheet.
If the economy responded to the extra money with higher inflation, and the central bank was unable to lift interest rates to curb it, then an “inflation tax” would be paid by the community as people faced higher prices for everyday goods and services.
Dr Lowe said if higher interest rates did stop inflation, either the government could pay the central bank back with money that would come from higher taxes on the community or it could simply not honour its loan.
The central bank would start to accumulate losses that would threaten its very future.
“This would lead to a decline in dividends to the government and possibly a future recapitalisation of the central bank. Both have to be funded through tax revenue,” he said.
“It certainly is possible for the central bank to change when and how the spending is paid for, but it is not possible to put aside the government’s budget constraint permanently.
“Where countries have, in the past, sought to put aside this constraint the result has been high inflation.”
The governor said some supporters of alternative funding arrangements argued that these problems could be avoided if a central bank provided free money up to a point where unemployment and inflation targets were met.
But he said there would be “very significant challenges” to maintaining those sort of restrictions over time.
According to the governor, none of this should be countenanced in Australia where the federal government could borrow freely at record low interest rates.
He said the government, which this week is expected to forecast a record budget deficit of at least $200 billion with total debt already at an all-time high of $719 billion, should actually look at borrowing more money to help strengthen the economy.
“It is through this borrowing that we are able to smooth out the hit to our current income. For a country that has got used to low budget deficits and low levels of public debt, this is quite a change,” he said.
“But it is a change that is entirely manageable and affordable and it’s the right thing to do in the national interest.”
Shane is a senior economics correspondent for The Age and The Sydney Morning Herald.