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The measures being taken to help the economy - an explanation

The measures being taken to help the economy an explanation

The following article has been developed by the Global Economic & Markets Research team.

Across the world, governments and central banks are taking unprecedented steps to support people and businesses impacted by the economic impact of COVID-19.

  • Australia has announced stimulus packages totalling almost $A190 billion, equivalent to nearly 10% of the size of Australia’s economy
  • The US government has also announced stimulus packages also equivalent to around 10% of the size of the US economy although the details make us cautious about the stimulus impact
  • There is a plenty of money available to small businesses in Australia and it is cheap

Australian Federal and State governments and the Reserve Bank of Australia (RBA) are taking dramatic action in response to COVID-19. They are trying to build a bridge for the Australian economy and businesses until we can return to some kind of ‘normal’ activity. But nobody knows how long and how wide that bridge needs to be.

The Federal Government is trying to manage two competing targets at the same time: slowing the spread of COVID-19 by shutting down significant parts of the economy and directing significant amounts of money to those people and businesses impacted. More measures are expected.

Measures in Australia

  • The Federal Government’s two stimulus packages announced to date total $A83.8 billion
  • The RBA has announced a $A90 billion three-year funding package for banks, while the Federal government will also establish a $A15 billion funding package for non-bank lenders

These packages total almost $A190 billion, equivalent to nearly 10% of the size of Australia’s economy. It is a significant amount.

The RBA has stated it won’t cut its benchmark interest rate below the current level of 0.25% and that this interest rate will likely remain at 0.25% for three years.

With traditional interest rate cuts now exhausted, the RBA has commenced “quantitative easing”, also known as printing money. Each day it is in the financial markets buying bonds that have been issued by the Federal and State governments. Its aim is to keep the bond market functioning, as well as keep the three-year government bond yield around 0.25%. 

The three-year government bond yield is the benchmark rate against which banks usually fund themselves in the bond market and that banks use as a reference rate when lending to businesses. Keeping that bond yield low, means banks can continue to fund themselves at low interest rates and extend loans to business and retail customers at low rates. As of Thursday 26 March, the RBA had bought bonds worth $A18 billion since 20 March. 

Where is all this money coming from? The RBA is essentially printing money to buy the bonds in the market. The Federal Government will have to borrow money to fund the $A83.8 billion stimulus packages by issuing new bonds. The RBA will buy some of those bonds using newly created money. 

Measures in the US

The US government has announced a $US2.2 trillion stimulus package worth roughly 10% of the size of the US economy. But it isn’t as big as it first looks:

  • Much of it is loan guarantees rather than direct injections into the economy;
  • Municipalities, the US equivalent of Australia’s local governments, spend twice as much as the US Federal government. By law many can’t run a budget deficit (by spending more than they are receiving from taxes, etc). So, despite COVID-19-related shutdowns, municipalities may have to crimp spending rather than lift it. 

Meanwhile, the Federal Reserve, the US equivalent of the RBA, has recommenced quantitative easing. It is buying bonds in several segments of the market to keep markets functioning and ensure credit continues to flow through the economy. It also has a program to help banks lend to small business.

So like Australia, there is a plenty of money available and it is cheap.

Source: Commonwealth Bank of Australia, Global Economic & Markets Research report ‘Economic Update: The next fiscal response is here – Making the ‘bridge’ longer and wider published’ by Stephen Halmarick on 22 March 2020. ‘Bonds & Rates Strategy: Daily Wrap’ published by Martin Whetton on 25 March 2020. ‘FX Daily London and Asia Open’ published on March 25 by Kim Mundy and Joseph Capurso. Full Global Economic & Markets Research disclaimers can be found at www.commbankresearch.com.au.

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