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The Australian Government is engaging in quantitative easing for the first time. The RBA is creating money that is being used to buy bonds on the secondary market so that there is enough liquidity for banks and financial institutions to buy new bonds to fund the covid stimulus measures.

Why are financial institutions necessary as an intermediate step? Why not fund the measures directly from the RBA without introducing additional debt (and the associated interest)?

I'd also be curious to know if Modern Monetary Theory has a different answer to this question than conventional economics.

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  • $\begingroup$ The risk to this question is that answers may end up being opinion-based. I’m in the MMT camp, and yes, MMT suggests a different view on things. One can debate how far the MMT view is from the mainstream. As such, I don’t think that part of the question can get a satisfactory answer. $\endgroup$ – Brian Romanchuk Apr 25 '20 at 15:29
  • $\begingroup$ I don’t have time to research this, but unless someone shows up to answer this, the odds are that the legal framework does not allow the RBA to directly fund the Treasury/Ministry of Finance. Canada is one of the few developed countries that allows this currently, and I had not heard that Australia is an exception. The MMT economist Bill Mitchell is Asutralian, and he may have discussed this. $\endgroup$ – Brian Romanchuk Apr 25 '20 at 22:03
  • $\begingroup$ Thanks for this response. I should've been clearer that I'm more interested in the technical reason rather than the legal. ie If the law were changed to allow direct funding by the RBA, would that be a bad thing? $\endgroup$ – ChrisJ Apr 26 '20 at 22:17
  • $\begingroup$ I’m not supposed to answer the question as a comment, but from the MMT perspective, it makes no economic difference. From other perspectives, there are differences, but a lot of them are just a question of semantics. $\endgroup$ – Brian Romanchuk Apr 26 '20 at 22:46
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As noted in comments, the reason why the RBA acted the way it did most likely comes down to its legal framework. Before the 2020 crisis, very few countries allowed their central bank to directly fund the fiscal arm of the government, which I will call the Treasury. I had often seen Canada cited as the only developed country that allowed the central bank to buy government bonds at auction (I am unsure that no other example exists). I think such financing was allowed in the 1945-1970 period in more places.

I know very little about the legal framework the RBA operates under. I will instead just discuss the economic effects.

The Modern Monetary Theory (MMT) view is that the addition of banks into the loop does not matter. Having the Treasury issue bonds that are just bought back bu the central bank - which is owned by the Treasury - has exactly the same economic effect as the Treasury directly borrowing from the central bank.

If we look at the mathematical models used by other economic theories, they say the same thing, since the final balance sheets are the same. The usual description of this is that this is “money financed deficits.” However, the argument seems to be that the difference is that behaviour of the fiscal arm will change, and so there is a greater bias towards inflationary policies.

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In regard to the purchase of bonds by the central bank I wrote the following paper which is called Financial Instrument Generation in the U.S. Financial System.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2458563

Based on the U.S. flow of funds I divide the balance sheet positions and transaction flows into four sectors: central bank (Fed or RBA), Treasury department of the federal government, Banks, and Nonbanks. In terms of double-entry accounting customs every sector has a balance sheet based on a Chart of Accounts. The flow of funds statistics use these principles but did not incorporate the four sector model exactly in their structure.

When a central bank (CB) debits an asset account for an increase it also credits a liability account for an increase which expands the CB balance sheet. When the federal government runs a deficit, is issues net new Treasury securities in the float of federal "debt" (the secure savings of other units) and when it runs a surplus it retires securities from the float by letting them mature without replacement to dispose of the surplus.

Bill Mitchell, an MMT proponent, describes and illustrates currency, reserves, and Treasury securities as financial assets stored in the Non-Government tin shed accumulating at the rate of Government deficits over the history of the nation:

http://bilbo.economicoutlook.net/blog/?p=381

Stephanie Bell Kelton, an MMT proponent, in essence argues that the sale of Treasury securities is simply the payment of interest by the Fiscal agent to help the Monetary authority maintain control over the policy rate of interest.

http://www.levyinstitute.org/pubs/wp244.pdf

The MMT position is to consolidate the CB balance sheet with the Treasury balance sheet kept as the fiscal branch of federal government. This cancels the mutual assets and liabilities on the consolidated balance sheet to form a three sector economy with the Sovereign government, Banks, and Nonbanks.

But then inside the Sovereign government there are two cooperative yet distinct operations of the Fiscal agent (Treasury function) and Monetary authority (central bank).

So in terms of your question there are the two operations called fiscal and monetary policy and there are the two kinds of liabilities which pay zero interest (high powered money in the form of national currency and central bank liabilities) or which pay interest (interest on bank reserves and Treasury securities). In general the Bank and Nonbank sectors are given the option to hold the zero interest liabilities or to earn some interest so that the Monetary authority retains control over some policy rate in the money markets. Also if the fiscal authority does not authorize deficit spending then the monetary authority can independently purchase less liquid financial assets from Nonbanks to provide more liquid financial assets to Banks and Nonbanks via so-called Quantitative Easing. The interest paid by the government is just a tool of Monetary policy and is of no great consequence compared to other concerns for managing the affairs of the nation.

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