It did this to put downward pressure on interest rates to stimulate the economy and to soothe dysfunction in the market at a time it was being flooded with bonds issued by the Treasury to pay for the Covid response.
Finance Minister Grant Robertson provided the RBNZ with a Crown indemnity to cover any losses incurred by the programme. He did so knowing the value of the RBNZ’s bond portfolio would fluctuate depending on how interest rates changed.
As it turned out, inflation became a major problem, so interest rates rose by more than widely expected.
Accordingly, the bonds owned by the RBNZ have lost value. The RBNZ is realising this loss as it sells the bonds it bought back to the Treasury to normalise the size of its balance sheet to make it easier for it to potentially use money printing again in the future.
The Treasury last year started paying the RBNZ under the indemnity. This is money that could’ve been used for healthcare, infrastructure, etc.
When previously asked about the issue, Orr and his colleagues have explained the cost of the LSAP programme to the Crown should be considered alongside its benefits.
For example, the downward pressure it put on interest rates lowered the Crown’s borrowing costs. Lower interest rates also helped stimulate the economy, which increased the Crown’s tax take.
As for the smooth functioning of the bond market at a time New Zealand needed to issue a lot of debt – it’s hard to put a price on that.
Central banks exist to fulfil their policy mandates
Nonetheless, because of the size of the direct losses central banks around the world face, the issue is making headlines.
Orr acknowledged this when he spoke at the Waikato University conference, but took issue with the situation being framed negatively in a question from the audience.
“I notice an emotion there. You use the emotion, ‘bad’,” Orr told the audience member.
He said central banks’ financials don’t “make any difference to the actual central bank unless somehow their credibility is being attacked – i.e. you’re printing money with no sense of ever making low, stable inflation through time”.
“So that’s the Venezuela, or the Zimbabwe, or the Argentina,” Orr said.
“Meanwhile, [for] central banks who are committed to low and stable inflation and have that credibility, the equity in the balance sheet is effectively noise...
“It’s a reputation challenge and it’s about balancing reputational, operational and legal risk.”
Orr noted the Bank for International Settlements (BIS) – a global organisation of which the RBNZ is a member – was on a “public mission” to tell people, “Calm down; it’s okay”.
The BIS, in a report published last month, argued, “While central bank losses will affect the consolidated public finances, serving as a source of revenue for governments is not the purpose of a central bank: they exist to fulfil their policy mandates, including price and financial stability.
“Thus, the success of their interventions should always be judged on whether they fulfil these mandates…
“Crucially, episodes of negative equity or recapitalisation should not be an opportunity for the Government to exert pressure on how the central bank discharges its mandates.”
Is the cost worth it?
Spencer, who left the RBNZ in 2018 and is now an adjunct professor at Victoria University, said central banks should still be mindful of the impact their policies have on the public purse.
As for the success of the LSAP programme, he believed it didn’t lower interest rates very much.
“The main benefit was that it smoothed the disruption to the bond market that occurred in April/May 2020 when there was some real volatility in the bond market and bond rates spiked up,” Spencer said.
“After that, the rest of the purchases, I would say, had very little effect on the term structure of interest rates.”
In hindsight, Spencer believed the RBNZ could’ve stopped printing money to buy bonds in mid-2020, rather than continue purchasing increasingly small volumes until mid-2021. This would also have reduced the size of the losses the RBNZ is currently incurring.
A peer reviewer of a five-yearly review the RBNZ did in 2022 of its monetary policy came to a similar conclusion.
Former Bank of Canada deputy governor Lawrence Schembri noted that while the RBNZ’s initial intervention in the bond market was “appropriate” and “had the desired impact on market liquidity”, the central bank’s decision to increase the size of the LSAP programme in June 2020 “provided much less monetary stimulus”.
Accordingly, Schembri said the “net benefit, once all the costs are considered, is much less clear”.
Given the size of the LSAP programme, he also said the losses posed a “significant risk to the consolidated public balance sheet”.
This risk can be seen in the Crown accounts. The interim statements for the six months to December 2022 show interest costs related to the LSAP programme (interest costs on banks’ settlement deposits at the RBNZ) exceeded Treasury forecasts, published in December 2022, by up to $400 million.
