Bank of Canada officials are getting increasingly testy at suggestions the central bank is enabling a spending spree in Ottawa by vacuuming up federal debt to the tune of $4-billion a week.
Governor Tiff Macklem and other central bank executives have used recent public appearances to refute charges that the bank’s quantitative easing (QE) program, which technically aims to lower long-term interest rates, is doing double duty by facilitating a near doubling of federal spending as Ottawa opens the floodgates to support the economy through the pandemic.
By sticking to explanations of the mechanics of the extraordinary monetary stimulus undertaken, Mr. Macklem and his colleagues have avoided questions about the consequences of QE and unprecedented expansion of the monetary base it has entailed.
Some experts believe the Bank of Canada and its counterparts in the United States and Europe have embarked on a course of debt monetization as their economies lurch from crisis to crisis. And they worry that domestic politics will make it very hard to reverse course.
The Bank of Canada dived headfirst into quantitative easing this year as the COVID-19 pandemic struck. The large-scale purchases of Government of Canada bonds – more than $180-billion since March, and counting – just happened to coincide with the massive increase in federal borrowing needed to fund programs such as the Canada Emergency Response Benefit. But the bank has insisted there is no connection between the two.
“We are not financing the government,” Mr. Macklem said during a Nov. 26 appearance before the House of Commons standing committee on finance. “Our actions, by lowering interest rates and by buying government bonds, are lowering the cost of financing the government. In fact, they’re lowering the cost of borrowing for everyone.”
It is technically true that the central bank does not directly purchase new bonds issued by the government. Rather, it buys them on the secondary market from large financial institutions that participate in weekly government bond auctions. It completes these purchases by creating new money in the form of reserves on the central bank’s balance sheet.
The primary effect of the Bank of Canada’s QE program is to drive up the price of government bonds, hence lowering their yields. That, in turn, pushes long-term interest rates lower across the financial system, encouraging consumer and business borrowing. It is hoped that the additional borrowing will stimulate economic activity, leading to a recovery and an increase in inflation more or less in sync with the bank’s target rate of 2 per cent.
It is widely acknowledged, however, that QE in other countries has contributed to increasing income inequality and the creation of asset price bubbles. That also appears to be the case in Canada since March. While millions of lower-income Canadians are working fewer hours or not at all, stock and house prices have been unusually buoyant.
Bank of Canada deputy governor Paul Beaudry last week defended the bank’s QE initiative by insisting that “we’re not providing a free lunch for the government. The government will have to repay the bonds that we purchase through our QE program when they reach maturity.”
Still, as Mr. Macklem said in his testimony before the committee, the bank is “buying fewer bonds at shorter maturities, and more and more at longer maturities.” That pushes the unwinding of the bank’s bond purchases years into the future.
If the bank continues its QE program indefinitely, as it has vowed to do, it could lead to a permanent increase in the monetary base. The federal government could simply repay existing bonds with new ones that also end up on the central bank’s balance sheet.
This is already effectively the case in the United States and Europe. The U.S. Federal Reserve promised to unwind its purchases of Treasury bonds after the last financial crisis. But it did not get far before the pandemic. It has now committed to purchasing an additional US$120-billion each month in Treasuries and mortgage-backed securities.
The European Central Bank had vowed that, under its QE program, it would hold no more than a third of government debt issued by eurozone countries. It has now blown past that threshold and last week announced another massive increase in its QE program.
“This is carte blanche for the finance ministers,” Commerzbank chief economist Joerg Kramer told The Wall Street Journal. “The ECB is likely to de facto finance the entire 2021 budget deficits of the euro countries.”
The Bank of Canada deserves unambiguous praise by moving decisively to prevent financial markets from freezing up when governments imposed strict pandemic lockdowns in March. But it has been treading on thinner ice as the aims of its QE program become murkier.
Most market participants do believe the bank is at least indirectly financing the government by becoming the largest purchaser of federal bonds. What’s more, the central bank has no idea when it will be able to unwind these purchases, lest it send markets into a tailspin.
It looks an awfully lot like debt monetization, or a permanent increase in the monetary base to fund the government. Debt monetization has a history of ending badly almost wherever it has been tried. That may explain why the central bank executives seem so touchy these days.
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