Last May, Finance Minister Grant Robertson asked policy wonks at Treasury for advice on whether he should let the Reserve Bank Labour needs to throw conservative spending plans out the window

A Treasury paper, released to Stuff under the Official Information Act shows Robertson asked for advice on whether the Bank should be allowed to buy up billions of dollars of Government debt on the primary market.

Treasury thought it was a bad idea, warning the move would risk long term damage to the reputation of New Zealand’s public finances, creating the “perception that New Zealand’s strong institutional frameworks have been undermined”. This bad reputation could make it difficult for the Government to borrow in the future

Robertson took Treasury’s advice, and the Reserve Bank continued buying debt on the secondary market.

But the advice is itself interesting, as it gives an insight into Treasury’s thinking on one of the most interesting areas of fiscal and monetary policy: whether the Reserve Bank should just print money and give it to Treasury to spend.

This was only theoretical a year ago, but as Stuff has previously reported, it’s become something Treasury and the Reserve Bank have contemplated this year.

The paper, released to Stuff, doesn’t go so far as to contemplate Robertson being able to call up Reserve Bank Governor Adrian Orr and ask him to print money. It simply gives Treasury’s advice on what some would say is the first step in that direction.

Why does the Government-owned Reserve Bank buy bonds from the Government?

Purchasing debt (issued in the form of bonds) on the primary market means that instead of purchasing bonds from third parties like banks and investors, the Reserve Bank would buy the bonds directly from Treasury itself. One part of the Government would buy bonds issued by another part of the Government, cutting out the middleman.

It’s a big move.

Since the 1990s, the Reserve Bank has been strictly independent of the control of the finance minister and Treasury.

The Bank uses the setting of interest rates to make sure that prices remain stable and employment remains at its maximum sustainable level. The Bank’s independence means that finance ministers aren’t allowed to use the Bank’s arsenal of tools to their own advantage, for example by lowering interest rates close to an election.

Crossing the Rubicon

But in the age of Covid-19 this has come under strain. At the beginning of the pandemic, the Reserve Bank fretted that it was losing its ability to control interest rates; they were rising when the Bank wanted them to be falling.

As a solution, it started to purchase billions of dollars worth of Government bonds from banks and investors. This enormous demand for bonds pushed interest rates back down to where the Reserve Bank wanted them. The Bank at that point promised only to purchase them on the secondary market, not directly from Treasury itself.

This is important. The bank is buying bonds to make sure interest rates are low, it’s not buying bonds to help keep borrowing costs low as a favour to the Government, that’s just a helpful side effect. The Bank’s independence means it isn’t there to help out the Government when it gets into an expensive pickle.

Buying up Government bonds on the secondary market, although fairly common internationally, already inches the Reserve Bank into awkward territory when it comes to its independence. If it were to suddenly stop purchasing the bonds, Government borrowing rates would rise, much to the ire of the Government which would like to keep them low.

Buying bonds on the secondary market as opposed to straight from Treasury is a helpful barrier against Treasury and the Reserve Bank getting too comfortable.

What does Treasury think?

Back in May last year, when New Zealand was still in the thick of a serious economic contraction, the Reserve Bank asked Robertson to indemnify another round of bond purchases.

According to the paper, Robertson said he’d take the proposal to a Cabinet committee and asked Treasury whether the Bank should start purchasing the bonds directly from the Government.

The strongest reason for the Reserve Bank buying bond directly from the Treasury is to avoid having to pay a transaction cost when buying from a third party seller.

“[W]hen purchasing NZGBs [bond] in the secondary market, the Bank may pay a premium compared to the primary issuance price of the bond.

“In this sense, an intermediary ‘clips the ticket’ between the Treasury issuing the bond and the Bank acquiring it,” the advice said.

But saving the Crown money wasn’t enough to sway Treasury’s opinion, this is because the goal of the Reserve Bank’s bond-buying (known as LSAP) is to lower interest rates, not save the Government money. The best way to do this was by buying bonds on the secondary market, said Treasury.

“Transaction costs are very difficult to quantify, and depend on differences in the timing and composition of NZGB issuance and LSAP purchases.

“Furthermore, the Crown incurring such fiscal costs is consistent with the objective of LSAPs. By supporting prices in the secondary NZGB market, LSAPs help to lower private sector bond yield,” the advice said.

Another objection was that the Government might not issue enough debt for the Reserve Bank to buy if it wanted to lower rates.

Getting a bad reputation

But Treasury’s biggest concern was that skipping the secondary market would give New Zealand a bad reputation as it would look like the Reserve Bank was simply printing money for the Government to spend.

This would make New Zealand’s debt less valuable, meaning that in the future we’d have to pay people more to buy it, which would increase the cost of borrowing for the Government.

Treasury thought this was a serious concern.

“Market participants and commentators may interpret that LSAPs are being directed foremost to support Crown borrowing requirements, and that monetary policy objectives have been made a secondary consideration.

“These reputational risks are likely to be greater for non-market purchases, where there is less transparency,” the advice said.

And Treasury noted that, ironically, if buying debt on the primary market pushed up borrowing costs it would undermine the whole purpose of what the bank was trying to do anyway, which was to reduce interest rates.

“In turn, reputational risks jeopardise the effectiveness of monetary policy. Primary purchases would reduce the supply of bonds available in the market, which would normally reduce government bond yields.

“However, investors’ concerns about institutional reputation could cause yields to increase, increasing interest rates in New Zealand more broadly,” Treasury warned.

“A perception that New Zealand’s strong institutional frameworks have been undermined could impact on New Zealand’s credit rating and inflation expectations, which could increase the cost of borrowing more generally,” Treasury said.

Perhaps most severely, Treasury warned that these negative effects would be long-lasting, as it would take some time for New Zealand to build back a reputation for good institutions if it was lost.

“Potential negative impacts arising from institutional reputation, transparency, investor demand, market function and liquidity are likely to have impacts on borrowing costs that last much longer than any shorter-term impacts on net debt and/or leakage to the private sector.

“This is because it will take time after any LSAP programme is completed to rebuild confidence in institutions and market infrastructure. Borrowing costs may remain elevated until this occurs,” Treasury said.

The idea was hovering in the air in May, when senior Treasury and Reserve Bank officials prepared advice for Robertson on the implications of doing exactly what Treasury warned against: just printing money to pay for the Government’s borrowing. Once again, officials cautioned against it and the Government heeded their advice.