Monetary policy is a hornet’s nest. It is a blunt economic tool that inevitably has a significant impact on the income distribution in society. No matter how much central bankers claim to be acting in everyone’s interest, the choices they make almost always benefit some people more than others. This has always and everywhere made them suspect, and not always without reason, among a certain subsection of the population that is wary of distant institutional elites.
To control for this problem, democratic governments have moved to provide their central banks with operational independence from elected politicians. While legislatures determine the mandate of the central bank, it is up to the bank itself to determine how it goes about fulfilling it. While it can sometimes act in concert with the government, it never does so at its behest.
For almost three decades leading up to the COVID-19 pandemic, Canadians had little reason to question the independence of the Bank of Canada. The adoption of a formal 2-per-cent inflation target starting in 1991 provided unambiguous clarity about the Bank of Canada’s raison d’être. Financial markets had confidence in the bank’s ability and determination to keep inflation low and stable. Everyone seemed to agree that, when it came to monetary policy, boring was best.
Things got a lot less boring in 2020 when the Bank of Canada delved into quantitative easing (QE). It began buying $5-billion worth of government of Canada bonds each week on the secondary bond market, eventually purchasing more than $300-billion in federal debt over a two-year period. The purchases happened to correspond with unprecedented spending by the federal government, which distributed pandemic-related cash relief to almost anyone who asked for it.
Contrary to the assertions of Conservative leadership candidate Pierre Poilievre, the central bank’s government bond buying did not technically constitute “printing money.” But nor did QE amount to a simple accounting entry, as some of the bank’s apologists claim.
By hogging the market for federal bonds, the bank ensured Ottawa could borrow cheaply and effortlessly. Without QE, the federal government would have faced higher borrowing costs and might even have found itself unable to find buyers for its mountains of new debt.
By driving long-term interest rates on government securities to near zero, quantitative easing also drove up stock and real estate prices as investors sought higher-yielding assets. The stock market and property boom that followed disproportionately enriched wealthier Canadians.
Taken together, hundreds of billions of dollars in pandemic relief and the wealth effect stemming from rising stock and property prices created more demand in the economy than the Bank of Canada bargained for. If global supply chain bottlenecks and surging energy prices lit the fuse of inflation, excess monetary and fiscal stimulus poured gasoline on the fire.
Contrary to another of Mr. Poilievre’s assertions, Canadians cannot “opt out” of inflation now by loading up on cryptocurrencies. All we can do is hope the Bank of Canada is able to rein in inflation without crashing the entire economy, though the odds of that are getting slimmer by the day.
“Public trust is fundamental to our ability to deliver on our mandate,” Senior Deputy Gov. Carolyn Rogers said in a Tuesday speech. “So, we are acutely aware that, with some of the extraordinary actions we have taken during the pandemic, and with inflation well above our target, some people are questioning that trust.”
The Bank of Canada is not alone in having waited too long to get serious about inflation. The U.S. Federal Reserve, which raised its key interest rate by half a percentage point on Wednesday, made even graver errors of judgment and the entire global economy risks suffering the consequences as the Fed executes a hasty course correction.
Both the Bank of Canada and the U.S. Fed squandered a good chunk of their credibility in the past two years by downplaying their core inflation-fighting mandates and engaging in mission creep as their officials mused about ensuring an “inclusive” recovery. No matter how desirable from a sociological perspective, economic inclusivity is outside of the bank’s purview.
That is why the Trudeau government’s December tweaking of the Bank of Canada’s inflation-targeting mandate, adding in the objective of supporting “maximum sustainable employment,” left so many observers worried. The language may sound progressive, and that is no doubt why Finance Minister Chrystia Freeland insisted on its inclusion. But it muddied the waters surrounding the bank’s primordial mission at precisely the wrong moment.
Governor Tiff Macklem and his colleagues are trying to make up for it now. They’ve ended their government bond buying program and are raising interest rates. But restoring the bank’s credibility as an inflation fighter, first and foremost, could now be a costly exercise for us all.
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