18 June 2019

Publication alert | Lessons from quantitative easing in the United States: A guide for Australian policymakers

It is possible the Reserve Bank of Australia (RBA) will need to lower the cash rate by more than its current level of 1.25 per cent to maintain nominal stability if there is adverse shock to the Australian economy. This will require the RBA to adopt a negative cash rate or change its operating instrument for monetary policy to the size and composition of its own balance sheet, also known as quantitative easing (QE).

A new report released today by the United States Studies Centre, examines the US experience with quantitative easing through the Federal Reserve. It shows how it is effective in improving macroeconomic conditions and that the supposed zero lower bound on official interest rates is not a constraint on the effectiveness of monetary policy.

Report author and director of the USSC's Trade and Investment program, Dr Stephen Kirchner, says the US experience shows that the RBA is not in danger of running out of ammunition.

"The cumulative effect of QE in the United States is estimated to have been the equivalent of a 250 basis point reduction in the federal funds rate, with effects on output and inflation comparable to a reduction in official rates, while reducing the unemployment rate by as much as one per cent," Dr Kirchner says.

"However, US experience also warns against the consequences of being too timid in the implementation of QE. The United States was slow to lower its official interest rate to near zero and embark on QE in the wake of the 2008 financial crisis.

"The first episode of QE was limited in size and duration. The Fed’s policy of paying interest on reserves also blunted the transmission of QE to the broader economy."

Key points

The US experience suggests the Reserve Bank would need to buy securities equivalent to around 1.5 per cent of GDP to achieve the same effect as a 0.25 percentage point reduction in the official cash rate.
There are good reasons for thinking QE could be much more potent in Australia if the RBA avoids making some of the US Fed’s mistakes. In that event, the size of QE in Australia could be much smaller as a share of GDP.
The mistaken belief that monetary policy is ineffective at the zero bound can mislead policymakers into relying too heavily on fiscal policy and other interventions to achieve macroeconomic stabilisation objectives.

View report