Australia has joined much of the developed world and begun engaging in what is commonly known as 'Quantitative Easing' (QE). The purpose of this post is to unpack what QE is, how it works, unpack some common myths (and answer any questions). 1. So, what exactly is the RBA doing? The RBA is making money ('printing') to purchase government bonds from the secondary market. The RBA have indicated they will buy however many bonds it takes to bring down the yield of 3 year government bonds down to 0.25% (the same as the cash rate on overnight funds). The bonds being purchased go onto the RBA's balance sheet. That is, RBA have transferred the money they created out of thin air to something real, government bonds. 2. Why are the RBA doing this? The RBA are looking to add monetary stimulus to the economy, but can't reduce the cash rate any lower (it's already at its lower bound). They want to reduce interest rates across the economy and provide liquidity to financial markets too (to promote risk taking and economic activity). Given they can't lower the cash rate (that targets overnight funds rate), they've chosen to influence interest rates settings in other markets. Overall, this is far less powerful than actually changing the cash rate itself. 3. So, where does the money that the RBA has 'printed' go? Contrary to popular opinion, they aren't dropping the money they're making into the street for the average Joe to spend. They also are not 'giving' the money to the government to give to Joe. Given the RBA are purchasing government bonds in the secondary market, it goes to the existing owners of these bonds. Financial market participants are the owners of these secondary government bonds. Government bonds are a very low risk asset, regarded as one of the safest assets in the world, particularly in Australia as one of 10 AAA government rated bonds in the world. They are a common asset owned by super funds, banks, etc. Therefore, the made up money is actually going into the hands of the owners of these secondary bonds. These bond owners have swapped their assets that they held for the RBA's printed money (cash). This cash injection to bond holders adds a lot of liquidity into the financial market. 4. What happens to the price of government bonds? Given the RBA have chosen government bonds to purchase, they have added a LOT of demand for this product. This drives the price of the bond up (more demand, price rises!). Given the price of the bond has increased, the yield of the bond has fallen. Prices & yields have an inverse relationship. To think of this as a property investor, when the price of any real estate asset rises & the rental income remains the same, the rental yield falls. This is the same with a government bond asset. 5. What impact does this have on broader interest rates? The governments interest rate on their debts is set by the government bond yield. This has come drastically down. This makes the ongoing cost of the governments debt lower. This has further consequences to wider interest rate settings too. The government yield curve impacts other interest rates in the marketplace, including the mortgage, consumer and business lending markets. Therefore, interest rates across the economy are coming down (particularly interest rates that are tied to longer time periods of the yield curve). 6. Why are the RBA targeting government securities? In general, the RBA only want the safest assets possible on their balance sheet in first instance. They are not looking to take much risk with the assets they are purchasing. Other central banks around the world have also purchased mortgage backed securities, which reduces funding costs & provides direct liquidity to owners of these assets (and helps reduce origination costs for those who rely on mortgage securities to fund). 7. What will happen with the government securities owned by the RBA? Eventually, the RBA will seek to take these bonds of their balance sheet, and 'sell them' back into the market. This will take 'money' out of the financial markets, and increase the cost of borrowing. This is similar to increasing interest rates. 8. Does this mean that they are giving the money to the government? The RBA's printed money isn't going to the government. It is going to financial market participants, which in turns has the impacts noted above. 9. So how are the government funding all of these policies (JobKeeper, etc)? The government can rely on its tax collections to fund its expenditures. When tax receipts are not enough, they can raise debt to fund their expenditure too. Government debt is viewed as a safe asset, particularly in Australia as it is one of 10 countries with AAA rated bonds. To raise debt, the Australian government issue primary government bonds (via AOFM). That is, the AOFM, on behalf of the government, sell bonds to the marketplace and raise cash. This cash is used to fund expenditures. That is, the government raises debt from financial markets to go and spend money. The RBA will not purchase this debt directly, but may purchase this from those who purchase the debt. 10. So, will 'printing' money lead to hyperinflation? The impacts of QE on economic activity indicators is reasonably similar to cutting interest rates (albeit, usually not as powerful). Rate cuts technically should push up inflation around the edges. But inflation is a function of real demand. Real demand has fallen of a cliff, so inflation isn't really a worry at the moment. It will be very hard to get any meaningful inflation growth where economic demand falls of a cliff. Typically, where you get hyper-inflation from 'printing' money is when the government prints money to fund its expenditures (among other structural economic reasons). This is NOT happening in Australia. The government isn't printing money to fund its expenditure, it is BORROWING money. There's a very big difference in terms of its flow through to the real economy & inflation. When a government cannot borrow money any longer, it may need to resort to actions like printing money to fund its expenditure. This has happened in the past and history books have shown that this leads to inflation (hyperinflation). The Australian government can borrow money fairly easily - they can source funds from the the financial market by selling bonds (AAA rated).