David Dodge has some candid things to say about the powerful weapons that the current leadership at the Bank of Canada has unleashed to fight the COVID-19 crisis.
First, they’re doing the right thing. Second, the right thing – to “essentially print money” – could have uncomfortable consequences down the road.
“They’ve done what they needed to do,” the former Bank of Canada governor says in a telephone interview. “That is to ensure liquidity – that’s the prime job of the bank at this point in time.
“[But] this is not without consequences down the line.”
Mr. Dodge is talking about the decision last week by Governor Stephen Poloz and his deputies to not only slash the bank’s key interest rate – its primary tool for monetary policy – to 0.25 per cent, matching its record low, but to launch a massive government-bond-buying program that will inject money directly into financial markets and dramatically expand the central bank’s balance sheet. The program, which is a form of what central banks call quantitative easing (QE), is a first for Canada, although other central banks – most famously the U.S. Federal Reserve – leaned on QE in response to the 2008-2009 financial crisis.
Mr. Dodge, who headed the Bank of Canada from 2001 to 2008, is more qualified than most in this country to weigh in on such matters – and more willing than most with his qualifications to do so. While former Bank of Canada governors have traditionally shied away from publicly judging their successors’ actions, Mr. Dodge willingly brings his expertise and experience to the public discussion. He heads up a “crisis working group” recently formed by the C.D. Howe Institute, an economic think tank, to quickly assess and recommend Bank of Canada and government responses to the COVID-19 crisis.
“Let’s just call this simply what’s going on: We’re printing a lot of money to provide liquidity in the system,” Mr. Dodge says with characteristic bluntness. “Every country has issues when they print money. It will require inordinately deft management as we move out,” he says.
The primary worry around this kind of central bank money creation is its potential to ignite inflation. That’s something of particular concern to the Bank of Canada, which has long been one of the world’s leading proponents of using low and stable inflation targets as the guiding principle of monetary policy.
It’s notable that one of the key goals of past QE programs, from the Fed and others, was to actually stoke inflationary fires; they were fighting against a very real danger that the economy would slip into deflation. But Canada entered the current crisis with inflation already essentially at its 2-per-cent target. Even though the impact of the crisis will likely be generally disinflationary in the short term, there is a danger that a QE-infused money supply will contribute to inflation significantly overshooting the bank’s target when the economy rebounds – a rebound that many economists still believe could be quick and powerful when it comes, based on the enforced nature of the slowdown.
Mr. Dodge notes that the U.S. Fed’s greatly expanded balance sheet hasn’t proved to be the inflationary problem that many had feared, even when the U.S. economy returned to full capacity and continued to grow strongly. But he also wonders whether the United States, by virtue of having the world’s reserve currency, may be in an exceptional position in global markets to withstand the after-effects of QE.
“It’s not clear that all the rest of us – other than maybe China – can do that, without having some real repercussions,” he cautions.
One of Mr. Dodge’s key concerns is that the economic stimulus being provided by the Bank of Canada, at the same time as the federal government’s huge aid package, will accelerate demand in the Canadian economy – at a time when the COVID-19 economic shock, by its nature, has shut down the supply of goods and services.
“You’ve cranked up domestic demand without supply to meet it – so you’re [faced with] meeting it with foreign supply. That requires foreign capital inflows,” he says. “All of a sudden, you’re then beginning to run into balance-of-payments issues.”
A key, he says, will be restoring Canadian production of goods and services relatively quickly once the enforced shutdowns are rolled back, to meet all the supply that fiscal and monetary policy will fuel.
“If we can snap back reasonably quickly, and have goods and services available, and get people back to work, then we’ll work our way though it."
"If we can’t do that, then it ends up being a really big problem.”
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