Policymakers' responses to Covid-19 have made us acutely aware there's no such thing as a free lunch.
Seismic amounts of government (fiscal) and central bank (monetary) stimulus meant most people kept their jobs during a period of enormous uncertainty in 2020 and 2021. Those who owned property and shares also enjoyed windfall gains.
But now that the ambulance has successfully responded to the emergency, it's left us with a hefty tab and three-decade-high inflation.
It has also left taxpayers recapitalising the Reserve Bank of New Zealand (RBNZ) to the tune of several billions of dollars.
When the RBNZ launched its money printing, or Large-Scale Asset Purchase (LSAP) programme in March 2020, Finance Minister Grant Robertson provided it with a Crown indemnity.
He effectively told the RBNZ, "If the programme, used to lower interest rates and support financial markets, runs at a loss, we will recapitalise you."
As it's turned out, the RBNZ will need to use this guarantee – quite extensively.
The $54 billion of mostly New Zealand Government Bonds (government debt) the RBNZ created money to buy via the programme have fallen in value to the tune of $8.8b.
This paper loss will be realised as the RBNZ spends the next five years selling the bonds it bought.
Depending on how interest rates change over this time, the losses could end up being larger or smaller.
A Treasury report from mid-April, released to the Herald under the Official Information Act, details how the RBNZ will be paid out.
It explains the Crown will make monthly payments to the RBNZ over the next five years. The Treasury says the monthly payments, which began in May, will be valued at between $150 million and $200m.
Higher interest rates could result in higher payments, and vice versa.
There has been much debate over whether the RBNZ needed to print as much money to buy as many bonds as it did to achieve its inflation and employment targets.
Given inflation is now completely overshooting the RBNZ's 1 to 3 per cent target range, at 7.3 per cent, one could strongly argue it didn't need to do this type of stimulus. It could have intervened briefly in the bond market in early 2020 to help it function more smoothly, and then step away and leave a record-low Official Cash Rate to support the economy.
One could also argue all the monetary stimulus inflated asset prices far too much, making a possible downturn more painful and deepening the divide between the haves and have-nots.
These issues have been, and will continue to be, extensively debated.
But, if one accepts the RBNZ made the best call with the knowledge it had at the time when it decided to go down the money-printing path, one must question whether it could have done this in a more cost-effective way.
Could it have rolled out this type of monetary policy without needing to call on the Crown backstop?
To put the estimated $8.8b loss in context, it's equivalent to around half of what is spent on New Zealand Superannuation every year, or 2.5 per cent of the country's annual gross domestic product.
The RBNZ's position
When the RBNZ bought the bonds in 2020 and the first half of 2021, it knew it was buying them at a high point in the market.
It was becoming a very active player in the bond market, with the aim of increasing demand for bonds, hiking their prices and lowering their interest rates.
While both it and the Treasury knew the programme carried a lot of interest rate risk, they thought the economic outlook was so bad, interest rates would need to remain low for a relatively long period of time.
Indeed, bond-buying done in other countries after the 2008 Global Financial Crisis did not produce inflation and did not solicit very aggressive interest hikes like we are seeing now.
When the RBNZ decided it would start downsizing its balance sheet by, from this month, progressively selling the bonds directly back to the Treasury, it knew the bonds would be worth much less than it bought them for. Indeed, it is engineering a rise in interest rates, which affects bond prices.
Nonetheless, the RBNZ took the view it wants to clear the decks and normalise the size of its balance sheet. It said this would make it easier for it to potentially use bond-buying again in a future downturn.
So, it decided to sell $5b of bonds back to the Treasury a year. This will remove liquidity from the financial system and tighten monetary conditions.
Was there a better way?
Wigram Capital Advisors founder and economist Rodney Jones is among those who believes the RBNZ should have dumped the bonds quickly from mid-last year.
This would have meant it wasn't selling the bonds at such a low point in the market, locking in such extensive losses.
However, BNZ senior interest rate strategist Nick Smyth suspects it would have been impractical for the RBNZ to sell all its bond holdings within, say, a year without causing dysfunction in the bond market.
The Treasury would have had to find a wad of cash to buy the bonds so would have had to issue a lot of debt – fast.
Smyth believes that with the benefit of hindsight, the RBNZ should have started tightening monetary conditions before it did.
However, he notes that back in mid-2021, when Auckland was still facing severe Covid-19 restrictions, few people expected a period of high inflation, and thus relatively high interest rates, was just around the corner.
The RBNZ was already seen as a front-runner among its counterparts when it came to tightening monetary conditions. Most other central banks still aren't selling bonds.
The other question is, could the RBNZ not have simply held on to the bonds until the final tranche mature in 2041?
This was an option and would have aligned with what other central banks have tended to do. Although it still would have exposed the RBNZ to a lot of interest rate risk, which could have seen smaller or larger losses than the current $8.8b estimate.
Impact of LSAP programme unclear
So, clearly there's a reason people say it's easier to get into money printing than to get out of it, and "hindsight is a wonderful thing". Both platitudes ring true in this case.
The onus is now on the RBNZ and the Treasury to do a thorough public analysis of the LSAP programme to ensure lessons are learned for the future.
The Treasury, in its mid-April report, said the programme "played a significant role in reducing the Crown's finance costs by lowering interest rates and supporting overall economic activity during the Covid-19 pandemic". This economic activity also increased the Government's tax take.
The Treasury said the RBNZ in August 2020 estimated the LSAP programme shaved 50 to 100 basis points off New Zealand Government Bond rates.
But the Treasury conceded, "In the absence of a reliable estimate of the impact of the LSAP programme on economic activity however, the total impact of the LSAP programme will remain unclear."
With the programme currently estimated to come at a cost of $8.8b, taxpayers deserve more clarity.
Even the Treasury noted the guarantee the Crown is providing the RBNZ is "significantly larger" than other indemnity payments it's made in the past.