In normal times, tracking the Bank of Canada pretty much begins and ends with subtle shifts in interest-rate policy.
These are far from normal times.
Over the past two weeks, the Bank of Canada has introduced a dizzying set of financial-market instruments to which we wouldn’t normally give a second thought. Forget (for the moment, anyway) about the target for the overnight rate. Meet your new friends: term repos, bankers’ acceptances, Canada Mortgage Bonds and U.S. dollar swaps.
The Bank of Canada helpfully took a little break this week from its rapid-fire announcements of arcane financial-market supports to publish on its website a short guide to everything it is doing in the fight against COVID-19, and why. The bank – to the surprise of many – held off further rate reductions after an emergency cut of its benchmark overnight rate target three weeks ago. The short guide is a handy compendium of all the feverish paddling that our central-banking ducks are doing beneath the surface.
It all boils down to making sure problems in the system related to liquidity – essentially, the ability to quickly and efficiently move in and out of holdings in securities – don’t morph into more serious credit problems. At a time when access to credit is seen as the critical bridge to get families and businesses over widespread shutdowns of their usual sources of income, and when there are urgent demands on banks and governments to deliver funds, a seizing-up of the markets essential to the credit system could make a bad situation much worse.
“The central bank must therefore intervene to prevent a sudden contraction of credit when credit is most needed,” the bank said in its guide. “If Canadians can’t borrow to weather this economic storm, the impact on the economy would be worse, the recovery will take longer and there will be long-lasting damage to Canada’s productive capacity.”
It’s a useful metaphor to think of the markets in which the central bank is intervening as the “plumbing” of the financial system – not only because it’s usually out of sight and taken for granted, but more importantly right now, because it’s a finite pipe through which money flows. You try to jam too much through it all at once, it gets clogged.
The liquidity problems that have surfaced in funding markets – basically, the markets that serve as de facto credit cards for companies, banks and governments as they conduct their day-to-day and month-to-month business – stem from a sudden and enormous surge in the need to access credit and raise cash, in light of the unprecedented pressures stemming from COVID-19. A rush to tap into credit lines, and to liquidate holdings to raise emergency cash, has overloaded the pipes.
So the Bank of Canada is stepping in on several levels to act as plumber – and has indicated that it is prepared to do more as needed. The bank has introduced a program to buy bankers’ acceptances, a crucial funding market for small and medium-sized corporate borrowers. It established a Canada mortgage bond (CMB) program to purchase bonds that financial institutions use to fund residential mortgage lending and renewals. It introduced the Provincial Money Market Purchase program to help keep provincial governments’ short-term credit needs running smoothly. For financial institutions, it has loosened collateral requirements on borrowing from the Bank of Canada and launched a new standing term liquidity facility, to help the banks themselves deal with short-term stresses and keep their lending taps open for their customers. And at the very top of the market’s food chain, the central bank has expanded its program of buying Government of Canada bonds – which, as a benchmark for the bond market, are at the core of maintaining the stability of the entire system.
In many ways, the Bank of Canada has been preparing for these sorts of actions for years – taking lessons from the the 2008 financial crisis to develop a game plan to put to work when the next big shock threatened to tie up market liquidity. The central bank is much better prepared than it was at that time, and its rapid-fire actions to shore up market liquidity show it.
Similarly, the bank has also done the research to hone a set of still-unused tools in its monetary policy toolbox to further ease interest-rate conditions – things such as forward guidance, quantitative easing and negative rates all remain options to drive down borrowing costs.
But the bank has signalled pretty clearly over the past couple of weeks that its liquidity actions are prerequisite to further moves on rate policy. Making credit cheaper doesn’t do much good if the system for delivering it is broken. First things first.
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