Bank of Canada Governor Tiff Macklem shares with his counterparts in the developed world the burden of having to compensate for the failures of markets and governments.
It is reassuring that Mr. Macklem feels up to the task. But it is hard not to worry about hubris overtaking the central bank as it seeks to tackle problems that are beyond its ability to fix.
Contrary to the prevailing narrative, central banks do not possess superpowers to remediate the underlying causes of economic decline. Relying on central bankers to prop up markets indefinitely is a risky strategy that increases the odds of bigger crises in the future. Yet, Mr. Macklem has said little about the downside risks of extreme monetary intervention since he took over from Stephen Poloz in June.
“You have to have the mentality that you need to overwhelm this crisis,” Mr. Macklem recently told The Globe and Mail’s David Parkinson, describing the bank’s response to the COVID-19 pandemic and its purchase of more than $400-billion in government and private securities since March.
No one disputes that aggressive central bank intervention was needed to prevent financial markets from freezing up as the governments shut down their economies and undertook unprecedented emergency spending measures to blunt the impact.
Six months into the crisis, however, Canada appears to be following Europe and Japan in relying on semi-permanent monetary stimulus to compensate for the weak fundamentals that undermine the prospects for a market-led recovery.
An economy that needs permanent monetary crutches to function is not a healthy one.
Look at Japan. Several commentators have pointed to that country in dismissing concerns about the quantitative easing (QE) undertaken by the Bank of Canada since March as it hoovers up government bonds on the secondary market. Since the 2008-09 financial crisis, the Bank of Japan’s balance sheet has expanded to equal about 120 per cent of the country’s nominal gross domestic product, from about 20 per cent, as the central bank finances government deficits by printing money.
While Japan has avoided a depression, no one could argue that its economy is thriving. An aged population and sclerotic private sector continue to sap its dynamism. Yet, permanent monetary stimulus has spared Japanese politicians from having to undertake the reforms needed to improve the country’s economic competitiveness. The country has the lowest productivity growth among leading industrial economies.
As a result, Japan faces a sustained period of downward mobility and living standards. QE has resulted in rising inequality – owing to rising stock prices – and a disappearing middle class. The poverty rate, at nearly 16 per cent, is rising and above the average for member countries of the Organization for Economic Co-operation and Development.
No major central bank has increased the size of its balance sheet since the onset of this crisis faster than the Bank of Canada. The central bank’s assets more than quadrupled between March and the end of September, when they stood at $533-billion, equal to about a quarter of Canada’s GDP. The total includes more than $239-billion in Government of Canada bonds. The central bank says it is committed to buying a “minimum” of $5-billion in federal debt each week until, well, it decides otherwise. Weekly purchases exceeded $5-billion throughout September.
The Bank of Canada has also purchased more than $185-billion worth of provincial, municipal and corporate debt since March. Unlike its QE measures, however, most of these purchases involve resale agreements under which the seller, typically a large financial institution, has agreed to buy back the debt at a future date. Hence, these are considered low-risk transactions.
The upfront consequences of the central bank’s QE program are fairly apparent. Yields on Government of Canada bonds have plummeted to barely 0.5 per cent as the central bank sucks up inventory on the secondary market. Stock and housing markets have become even more inflated as investors count on never-ending monetary stimulus to keep the party going.
The central bank has been silent on the longer-term consequences of all this stimulus, however. Although it is independent of the government, the Bank of Canada remains governed by federal legislation and is accountable to Parliament. Sadly, the political class has all but abdicated its responsibility for monitoring a central bank whose interventionism keeps growing.
Here’s a question worth asking: Would Ottawa be able to finance a record deficit of exceeding 15 per cent of GDP without the central bank’s help? It is safe to say Ottawa would have faced substantially higher interest costs and pressure from investors to rein in spending.
So, what would happen if the Bank of Canada suddenly stopped its purchases of government bonds? That the central bank does not even want to entertain the question probably tells you all you need to know.
Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.