Bond purchases may have continued longer than warranted, BoC paper says

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The Bank of Canada’s program to buy government bonds may have been larger than necessary and continued for longer than warranted, according to an analysis by a top central-bank official published this week.

In the early months of the COVID-19 pandemic, the central bank intervened aggressively in financial markets to prevent them from seizing up amid a panicked dash for cash.

These lending and asset-purchase programs helped calm markets, Grahame Johnson, adviser to the central-bank governor and former managing director of its financial markets department, wrote in a paper published Wednesday. But several of the emergency programs took too long to wind down, and were not recalibrated as the bank’s goal shifted from preventing market failure to supporting the economy more broadly.

This is particularly true of the bank’s federal government bond purchases, which morphed from a market-support effort into a “quantitative easing,” or QE, program aimed at holding down interest rates. The bank purchased around $350-billion worth of federal government bonds from market participants in 2020 and 2021 – by far its biggest and longest-lasting emergency-response program.

“The initial rapid pace of purchases was necessary to address market functioning, but improving market conditions and the shift to a monetary-policy objective provided an opportunity to revisit both the structure and the scale of the program,” wrote Mr. Johnson, who was an architect of the bank’s response to the market turmoil in the spring of 2020.

“The question was whether $5-billion a week was still appropriate given improved market conditions,” he wrote.

The paper is part of a broader effort by the bank to understand its successes and failures over the past three years – which saw a rapid recovery from a severe economic crisis, but also a surge of inflation to the highest level in four decades.

The analysis arrives at a moment of heightened financial-stability concerns after the failure of several U.S. banks and the forced sale of Credit Suisse.

In a Wednesday appearance in Montreal, Bank of Canada deputy governor Toni Gravelle said that bank officials were “polishing off our contingency plans,” and were “ready to act” if financial turmoil in the U.S. spills across the border.

Mr. Johnson’s paper isn’t an attempt to analyze QE or the other asset-purchase programs from a monetary-policy perspective; it doesn’t assess their impact on interest rates or inflation.

But the paper does argue that the Bank of Canada should have been clearer with markets and the broader public when the goal of its federal government bond purchases shifted in June, 2020. And it should have been more flexible in how it approached a range of emergency measures, including its federal and provincial bond-buying efforts.

“In some cases, an initial commitment to (overly long) durations of the programs may have impeded the bank’s ability to scale the programs back. In other cases, the bank’s desire to avoid the perception of premature exit may have caused it to delay stopping the programs,” Mr. Johnson wrote.

He suggested that the bank’s provincial and mortgage bond-purchase programs should have used “penalty pricing,” which would have encouraged market participants to stop using the programs as soon as market conditions improved.

Meanwhile, the federal bond-purchase program could have benefited from “a more graduated and flexible approach” and clearer criteria for when it would end, he wrote.

In his Wednesday speech, Mr. Gravelle suggested that the bank would be reluctant to launch another government bond-purchase program, except in the most extreme circumstances. “The bar is very high,” he said.

The QE program, which ended in 2021, has created plenty of headaches for the central bank. It opened the bank up to allegations from politicians that it is monetizing government debt. Conservative Party Leader Pierre Poilievre, for instance, has called the Bank of Canada the government’s “ATM.”

The bank is also losing hundreds of millions of dollars each quarter on assets that it acquired in the QE program. That’s because it is earning lower interest on the bonds it bought than it is paying out on the reserves it created to pay for the bonds.