A new RBA framework has rewritten the rulebook for how the central bank will respond if interest rates are pushed back towards zero.
The Reserve Bank of Australia (RBA) has published its Framework for Additional Monetary Policy Tools at low interest rates, setting out how the Monetary Policy Board (MPB) would design and deploy “unconventional” tools such as bond buying and term lending facilities in a situation where the cash rate is constrained.
The framework draws heavily on the pandemic experience and comes alongside an assessment that those extra measures delivered limited benefits relative to their risks and fiscal costs.
6‑tool crisis kit and strict principles
The AMPT Framework identified a six‑part toolkit: term lending facilities, government bond purchase programs, forward guidance with commitment, negative interest rate policy, term rate targets, and foreign exchange asset purchases.
It said that the appropriate combination would depend on whether the shock is, for example, a financial‑system dislocation, a real‑economy slump, a slow grind down, or a mixed supply‑and‑demand event.
The framework also set four broad principles that any package must meet.
The RBA said it needed to align with the objectives of low inflation and full employment and be consistent with financial stability, offer reasonable expected benefits relative to short‑medium and long‑term costs; be operationally viable and flexible enough to adjust or exit; and take account of broader public sector policies and the consolidated public balance sheet.
The framework also said that some instruments – notably negative rates and large‑scale foreign exchange purchases – are reserved for exceptional circumstances.
Cash rate remains first line of defence
In launching the framework, assistant governor (financial markets) Chris Kent outlined the hierarchy of instruments the board intended to follow in any future low‑rate environment.
“At its core, the answer is pretty straightforward: rely on the cash rate target first and foremost, use additional tools if necessary,” he said.
“The pandemic showed a package of additional tools can provide valuable support in extraordinary times, but success depends on the context. It also highlighted important challenges in the design, the calibration, communication, exit, and broader risk management of the tools.”
He said that conventional easing did most of the heavy lifting when rates were cut to 0.10 per cent during COVID‑19.
“The most important support during the pandemic came from lowering the cash rate target to historically low levels and keeping it there,” he said.
Kent said that “unconventional” measures should now be seen as reinforcing existing tools.
“Additional tools can reinforce that sort of support, but their effects are likely to be more marginal, and their risks need to be managed carefully,” he said.
Kent said that the term funding facility and government bond purchases during the pandemic-era helped lower borrowing costs and stabilise markets, yet also exposed the public sector balance sheet to sizeable interest‑rate risk.
Subsequent rises in yields have left the bank with tens of billions of dollars in mark‑to‑market losses on its bond portfolio, while the impact on real‑economy activity was judged to be at the lower end of international experience, given Australia’s bank‑based lending structure and sensitivity to short‑term rather than long‑term rates.
Yield‑curve targets and time‑based forward guidance were singled out as particularly challenging, with the framework stressing the need for credible exit strategies and scenario analysis before any future use.
The RBA described negative rates as deeply unpopular in other jurisdictions and not technically ready in Australia.
How the board will decide next time
Operationally, the framework spells out a decision‑making process in which staff first assess the policy environment and the degree of stimulus needed, then design tools or packages consistent with the principles, identify and mitigate risks, consult the Governance Board, and determine what co-ordination is required with other agencies.
Staff are required to analyse how tools interact – whether one instrument reinforces or undermines another, alters the overall risk profile, or affects operational flexibility – and to subject proposals to internal review and challenge.
As part of that risk management, the bank will run “fire‑drill” exercises of severe but plausible scenarios with the MPB and Governance Board to test how the framework would hold up under pressure.
[Related: Bullock keeps hikes on table, says inflation too high]
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