The outlook for the global economy is “quite concerning” and will have implications for Australia, a Reserve Bank official has warned.
- The RBA says its emergency bond-buying program has largely met its goals
- Deputy Governor Michele Bullock says there are problems in the global economy that could jeopardize Australia’s recovery
- The RBA’s ability to create money has supported the economy during the pandemic
Deputy Governor Michele Bullock says there are mounting problems in the United States, Europe and China and things are “on a knife edge”.
The RBA still plans to raise interest rates further, she said, in part to convince Australians that high inflation isn’t about to take hold.
But there are a number of things that could go wrong in the global economy that would undermine the RBA’s attempt to safely navigate Australia through its rapid rate hike cycle, she said.
She has also explained how the RBA’s ability to create money has helped support Australia’s economy during the pandemic.
Many risks around the world
Ms. Bullock listed the main risks to the global economy.
She said China’s zero-COVID approach will continue to wreak havoc on global supply chains and Chinese demand.
The extensive problems with the real estate market in China were also of concern, as real estate accounts for a third of the country’s economy.
She said the United States was struggling with excess demand and rapidly rising wages and inflation, and that the Federal Reserve would have to continue raising interest rates “quite a bit” to dampen economic activity.
Then there was Europe, which had “its own problems”.
“It has inflation, but also a massive energy shock that will affect their production,” she said.
“So… I think the outlook for the global economy looks pretty uncertain and quite worrying and obviously that’s affecting us because of the bias [for those things] flow through to commodity prices.
“That’s something that I think is at the moment … very uncertain and on the razor’s edge,” she said.
The RBA will not go bankrupt
Ms Bullock made the comments during the Q&A session following a speech to Bloomberg in Sydney.
In her prepared speech, she spoke about the lessons the RBA had learned from using unorthodox policies during the pandemic.
She said the RBA’s extraordinary bond-buying program resulted in the bank holding about $356 billion in Australian government and government bonds by the end of June this year (see chart below).
She said the bond purchase program and other measures had largely achieved their goal and helped support the economy and employment in very uncertain times.
She said one result of the bond purchases was that the bank would report a significant book loss in its 2021/22 financial statements, leaving the bank in a “negative equity” position.
However, she said people don’t need to worry about that because central banks aren’t like regular banks.
She said there is no risk of the RBA going bankrupt.
“If a commercial company had negative equity, the assets would not be sufficient to pay the liabilities and therefore the company would be unable,” she said.
“But central banks are not commercial entities. Unlike a normal company, a central bank in a country like Australia has no going concern issues. Under the Reserve Bank Act, the government provides a guarantee for the Reserve Bank’s liabilities.
“Furthermore, because the bank can create money, it can continue to meet its obligations as they come due and is therefore not insolvent.
“The negative equity position will therefore not affect the Reserve Bank’s ability to do its job,” she said.
She said the RBA still thought it prudent to return to positive equity at some point in the future and it would eventually get there.
“Despite the fact that the bank can continue to operate with negative equity, the board believes that it is important for the bank to return to positive equity over time,” she said.
“The board has communicated this to the government. Although it has not requested a capital injection, the board has told the government it expects future profits to be retained by the bank until the bank’s capital is restored.
“The Treasurer supported this general approach and noted that under the Reserve Bank Act the issue of distributions to the government is reviewed each year,” she said.
She also said people should understand that the $356 billion in Australian government bonds held on the RBA’s balance sheet are actually liabilities issued by the federal government.
“While the bank will report a large valuation loss in 2021/22, the government’s debt issuer – the Australian Office of Financial Management (AOFM) – will report a significant valuation gain,” she said.
“For the government as a whole, therefore, the bank’s loss on this part of its portfolio is offset against the profit of the AOFM.”
She said the interaction between the AOFM and the RBA supports the money printing that has supported the economy during the pandemic.
“We can create money,” she said during the Q&A. “That’s what we did when we bought the bonds. We created money and bought the bonds.”
Overall positive result
Overall, Ms Bullock said the policy actions being taken by the RBA in the pandemic are a good thing for the economy.
“Because of all these extraordinary measures, the economy has performed very well,” she said.
“The budget deficit is looking a lot better this year and one of the reasons for that is that social security benefits have come down and that’s because unemployment is at its lowest level in 50 years and the bond purchase program … has helped,” she said.