Reflecting on the fifth anniversary of the financial crisis, Finance Minister Jim Flaherty declared that he is “opposed to quantitative easing, printing money.”
According to a new paper by the International Monetary Fund, Mr. Flaherty has little to worry about.
Ministers such as Mr. Flaherty grumble about quantitative easing – or QE, which refers to the policy of creating money to purchase financial assets such as bonds and mortgage-backed securities – because they think the bigger economies that deploy it are doing so with little regard for how their unconventional measures affect the rest of the world.
That could be. The job of the Federal Reserve is to take care of the U.S. economy. When Fed Chairman Ben Bernanke mused in May that the the U.S. central bank could be nearing the stage when it would slow the amount of money it creates each month to buy bonds, markets reacted dramatically.
Longer-term interest rates in the United State jumped a quarter-point in the immediate aftermath of those comments. Canadian rates, which historically are linked to U.S. rates, jumped by almost the same amount, bringing about a tightening of financial conditions that the finance minister of a country that is struggling to maintain any economic momentum wouldn’t necessarily welcome.
When policy makers say the exit from the use of extraordinary monetary policy will be bumpy, this is what they mean.
But Canada should be well placed to stand a little turbulence, according to paper by IMF staff called “Global Impact and Challenges of Unconventional Monetary Policy,” which was released Monday in Washington.
The paper concludes that the benefits of unconventional policy – QE and extraordinary forward guidance, such as linking the timing of interest-rate increases to specific economic conditions – outweigh the costs. And while the way back to normal could get rough, the report says there is little evidence yet of any serious collateral damage.
Canada, Australia and South Korea are singled out explicitly as three countries that have little to worry about.
IMF economists studied 13 advanced economies and major emerging markets that avoided unconventional monetary policy. Countries were assessed for their “exposure” to eventual tapering of QE – the extent to which their domestic financial markets are vulnerable to a shift in global conditions brought on by tapering – and their “resilience” to potential market volatility.
Canada is well placed on both scores, the IMF said. While longer-term interest rates jumped in tandem with U.S. rates with Mr. Bernanke’s talk of tapering this spring, international capital flows were little changed. As one of a shrinking number of countries with an unblemished credit rating, there is little reason to worry about capital flight.
And Canada’s financial system should protect the economy from any serious damage from QE exits just as it proved a bulwark during the financial crisis. The IMF paper notes that Canada’s domestic capital market is relatively deep. Nor is Canada particularly exposed to currency volatility – at least when it comes to the financial system -- as a “sizable fraction” of its external liabilities are denominated in Canadian dollars.
The fund does point out a potential vulnerability to tapering, which will come as little surprise to anyone at the Finance Department or the Bank of Canada. The authors of the report note that longer-term interest rates could “overshoot” once the U.S. begins to pull out of the bond market.
Canadian borrowing costs could follow, which would deal a blow to the housing market – or, as the IMF puts it, a “disorderly rebalancing of housing prices.” A sharp drop in home prices would hurt household spending, as debt remains at historically high levels relative to income.
Just another reason the Bank of Canada is in no rush to raise interest rates.