Conservative Leader Pierre Poilievre is not the only notable Canadian pointing to the money supply, and the Bank of Canada’s lack of focus on it, as a key threat to our economic well-being.
One of the country’s most accomplished and respected monetary theorists is very worried about it, too.
But while Mr. Poilievre spent the past week blaming the Bank of Canada’s rapid expansion of money supply during the COVID-19 crisis for causing our inflation problem, Western University professor emeritus David Laidler issued a warning about the dropping of the next shoe. That same money supply has now slipped into contraction.
In a Globe and Mail letter to the editor, the 84-year-old retired economist warned that declining money-supply measures – a consequence of the central bank’s “quantitative tightening,” the unwinding of the government bond purchases it made during the pandemic – “warn of a downturn [in the economy] far sharper than the bank is predicting.”
This is certainly a step or two ahead of Mr. Poilievre, whose criticism has focused on the Bank of Canada and the federal government “printing money” during the pandemic, through the bank’s bond-buying strategy known as quantitative easing, or QE.
Dr. Laidler doesn’t disagree. Indeed, when I talked with him Wednesday, he reminded me that he and I had an e-mail exchange in early 2021, in which he fretted that the “double-digit” pace of money-supply growth would soon fuel rising inflation. (The latest Statistics Canada data show that as of August, the M2++ aggregate, a broad gauge of money supply, was up 26 per cent since the start of the pandemic; the narrower M1++ measure was up 35 per cent.)
But that’s yesterday’s news. Since the bank started raising interest rates and, critically, began its program of quantitative tightening, or QT, M1++ money supply – generally considered the most useful gauge of money in circulation and Canadians’ bank accounts – has declined six months in a row, by a total of 4 per cent. And the decline has accelerated: In the three months from June to August, M1++ was down at an annualized rate of nearly 10 per cent.
Actual declines in money supply don’t happen very often, and when they do, they’re typically small, short-term dips – like, two or three months. This current decline is both unusually steep and unusually sustained.
“In the past, the behaviour of [M1++] was a reasonably accurate forecast of what was going to happen to the real economy around nine months later,” he said. “If things work out as they did in the early 1980s and the early 1990s, we’re in for a pretty sharp downturn.”
“What the behaviour of the money supply is telling you at the moment … is that you’re maybe further along the road [to cooling demand and inflation] than you think you are, and you’re being tighter [on monetary policy] than you need to be,” Dr. Laidler argued.
However, it’s unclear how much attention the Bank of Canada is really paying to the money supply. Certainly, the spike in money growth early in the first year of the pandemic didn’t sway the bank to start an earlier unwinding of QE and ultralow interest rates. In the bank’s communications, discussions of monetary aggregates and their implications for inflation rarely come up.
That seems odd to Dr. Laidler – who, in the 1970s and into the 1980s, was one of the leading voices making the connection between global inflation problems and the money supply, and, by extension, arguing for the use of monetary policy by central bankers as the key tool to tame inflation.
Still, a focus on money supply feels like a relic from the past. Central bankers tried directly targeting money supply in the late 1970s, and it proved largely a failure. Dr. Laidler and others became proponents of setting explicit inflation targets and applying interest rates aimed at achieving them. It was an indirect way of influencing the money supply, and it was more straightforward and easier to communicate to the public.
Central banks adopted inflation targets in the 1990s, and they worked so well that, over the past two decades, money-supply talk has all but disappeared from the conversation.
That was further cemented in the aftermath of the Global Financial Crisis of 2008-09, when the U.S. Federal Reserve introduced QE and accelerated U.S. money supply – without triggering inflation. Many observers came to the conclusion that QE, and the resulting increases in money supply, were no longer necessarily inflationary. The current episode raises new questions about whether that was a mistake.
Now, the Bank of Canada is focused on a public message that it can and will bring inflation back to its 2-per-cent target, and that higher interest rates are its tool for achieving that. This may be why it is so hesitant to let money supply drift back into the policy conversation. The last thing it needs is to create any question that it has any policy target other than 2-per-cent inflation.
But to the extent that the Bank of Canada in its internal policy discussions has undersold money supply, it does so at its peril. The acceleration of money growth earlier in the pandemic certainly played a bigger role in the inflation we see today than the bank anticipated. Unless the bank pays heed to the sudden and sharp reversal of money supply that is now taking hold – unless it studies the phenomenon and understands it – it could set us on a path to further policy missteps.