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The Globe and Mail

Carney must react fast to protect Bank of Canada’s reputation

Mark Carney, Governor of the Bank of Canada, speaks during a CFA Society Toronto luncheon on Dec 11, 2012.

Fred Lum/The Globe and Mail

There has been quiet talk for some time that Bank of Canada Governor Mark Carney was seriously considering a run at the Liberal leadership but, until this weekend, it was only in the form of whispers.

A Globe report, however, has revealed that Mr. Carney had serious discussions with Liberal party insiders on his ability to defeat Justin Trudeau in a leadership campaign and even stayed at Liberal MP Scott Brison's house for a period of time – a likely violation of the bank's conflict of interest guidelines. If true, the allegations reveal a serious lack of judgment and threatens to taint one of the country's most vital institutions.

The Governor of the Bank of Canada has two primary tasks: Follow the bank's mandate as closely as possible and to keep the bank as free as possible from the appearance of partisan influence. The latter role can't be overemphasized.

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In 1970, inflation in the United States was running at nearly 6 per cent. The normal course of action in such a situation would be for the Federal Reserve to significantly tighten monetary policy. This would slow the economy and reduce inflation. However, the Fed, under chairman Arthur Burns, instead kept monetary policy quite loose, boosting an already overheating economy.

Mr. Burns was a highly respected economist and one of the leading macro-economists of his generation. How could he have made such an elementary error? The reports How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes and the follow-up The Political Business Cycle: New Evidence from the Nixon Tapes reveal that these were not policy errors at all, they were deliberate decisions made to boost Mr. Nixon's 1972 election chances. Mr. Nixon had blamed his 1960 presidential election loss, in part, on the tight money policies of Fed chairman William McChesney Martin. In an effort to ensure that history would not repeat itself in 1972, Mr. Nixon hired loyal Republican Mr. Burns as Fed chairman in 1970. Mr. Burns was subsequently threatened and bullied into keeping policy inappropriately loose.

Politically, the Nixon-Burns monetary policy was a smashing success, with Mr. Nixon winning a landslide in 1972. Economically, it was a disaster – unleashing a decade of inflation and stagflation which took three crushing recessions (1973-75, 1980, 1981-82) to eliminate. It also made the Fed's job far more difficult, as its decisions are now judged through a partisan lens: Are their decisions being made in the best interest in the economy or the best interest of a favoured political party? We saw this talk in the recent U.S. election, with some conservatives wondering if the Federal Reserve was actively trying to re-elect Barack Obama. This handcuffs the Fed from making difficult policy moves during election years. The Fed has been more aggressive with monetary policy post-2012 election; one has to wonder if this is a coincidence.

If monetary policy can be inappropriately used to boost an incumbent, it can also be used unsuitably to undermine an incumbent. While Mr. Carney was allegedly deciding whether or not to run for Liberal leader, I argued that his monetary policy has been too tight. Monetary policy works with "long and variable lags," so the effects of recent policy decisions will not be fully felt until late 2013 or early 2014.

What if Canada fell into a recession in 2014? Would the bank's failures to prevent a recession be due to factors they could not have foreseen, due to honest policy mistakes, or been due to Mr. Carney keeping policy too tight in 2012? Normally the idea that a central banker would deliberately slow the economy for partisan purposes is – and should be – written off as a wild conspiracy theory. Some people are likely to suggest that these questions can no longer be so easily dismissed. Investment analyst Henry Liu has argued that the "Fed, as an independent institution above politics, has yet to recover fully from the rotten partisan smell of 1972." A similar whiff could engulf the Bank of Canada.

The problems for Mr. Carney and the bank now reach beyond recent monetary policy decisions. A month before Mr. Carney had announced that he would not run for the Liberal leadership – famously retorting: "Why don't I become a circus clown?" – he gave a speech in Calgary critical of Tom Mulcair's position that Canada is suffering from Dutch Disease. He called Mr. Mulcair's position "overly simplistic and, in the end, wrong." It is unusual, though not unheard of, for the Governor of the Bank of Canada to weigh in on policy debates. His remarks were in all likelihood an independent attempt to stifle a stale talking point that had turned into a political football. That some will now almost certainly go back and parse his comments in an attempt to uncover even the slightest taint of partisanship is a major problem for the bank.

If the allegations are untrue, Mr. Carney must refute them as quickly as possible in order to protect the bank's reputation. If not, the bank must distance itself from Mr. Carney as quickly as possible and request his immediate resignation.

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