Bank of Canada Governor Tiff Macklem walks outside the Bank of Canada building in Ottawa, on June 22, 2020.BLAIR GABLE/Reuters
As he steers inflation back to Earth – the three-month annualized rate was 4.3 per cent in October, a third of its spring peak – Bank of Canada governor Tiff Macklem must surely take comfort in the knowledge that, should he need any advice on how to proceed, he need not rely only on the bank’s world-leading roster of economists, but can tap the deep wellspring of expertise on the opposition benches.
Just now they are sending somewhat conflicting signals. Where Conservative Leader Pierre Poilievre holds the governor to blame for inflation having reached such levels, NDP Leader Jagmeet Singh is equally concerned that he might do something to reduce it. For where Mr. Poilievre believes current inflation levels are solely and entirely a function of bank policy, Mr. Singh believes it is caused by everything but: corporate greed, profiteering, price-gouging.
Their prescriptions, likewise, are diametrically opposed. Besides firing the governor – he seems no longer to be advocating the wholesale adoption of bitcoin as a way of “opting out of inflation” – Mr. Poilievre has lately suggested he would alter the bank’s mandate to require it to keep inflation at 2 per cent, as is currently the target, but “with an eye not just to CPI inflation, but asset price inflation.”
For his part, Mr. Singh complains of the bank’s “one-size-fits-all” approach, which is to say its use of the instruments of monetary policy, such as interest rates, to control inflation, rather than addressing the “root causes” of price increases: along with greed, they include supply chain bottlenecks and the war in Ukraine, issues that are not widely considered to be within the bank’s ability to control.
There is some merit in both analyses: precious little in either, to be sure, but enough between the two of them to add up to something half-way sensible. Mr. Singh’s view that current inflation is mostly a result, first, of the supply chain bottlenecks that arose from the rapid reopening of economies around the world after the pandemic lockdown, and second, of the spike in commodity prices that followed Russia’s invasion of Ukraine, is supported by much economic research. (The argument that it was caused by a sudden increase in corporate greed, which would seem to be a constant, is not.)
But Mr. Poilievre is surely right to fault the bank for being too slow to unwind the massive purchases of government bonds it made in the depths of the lockdown, once the economy began to recover and price pressures began to appear. The bank may not have been responsible for starting the inflation that now bedevils us, but – pending a resolution to global supply chain problems and/or the Ukraine war – it bears absolute responsibility for ending it.
That is, he would be right, if that were in fact what he was saying. Rather, Mr. Poilievre insists the bank should never have embarked on the bond purchase program, a policy known as “quantitative easing,” to begin with, even accusing it of having acted as “the government’s ATM.”
Leave aside the insinuation that the Bank was acting improperly or under political pressure: what would have been the consequence had it not absorbed some of the enormous, indeed unprecedented supply of bonds that suddenly poured out of the federal government, at a time when every other government on Earth was doing the same?
Prices had already begun to fall that frightening spring of 2020; people and businesses had begun to hoard money. The spike in interest rates that would have followed, had the bank not met the sudden increase in the demand for money with an increase in supply, would almost certainly have plunged the economy into deflation and depression, made worse and more intractable as people put off purchases in anticipation of the lower prices to come.
Mr. Poilievre subscribes to a cartoonish version of monetarism in which any large increase in the money supply automatically translates into higher inflation. This is not actually what either theory predicts or real-world evidence confirms. The long-run correlation between money growth and inflation holds, but in the short run all sorts of other factors can intervene.
In the present case, the money that Mr. Poilievre thinks was injected into circulation, adding to demand and raising prices, does not appear even to have made it that far. Yes, the bank bought all those bonds – not directly from the government, but from the commercial banks; and yes, it bought them by creating liabilities in their favour on its balance sheet called settlement balances, short-term debt instruments on which the bank pays interest.
But the banks did not, in their turn, increase lending against those assets. They appear, rather, to have just sat on them. People haven’t been taking on a lot more debt in the past couple of years; they’ve been paying it down – partly with the benefit cheques the government sent them, with the money it raised by issuing all those bonds.
All the same, Mr. Poilievre is right to want the Bank to return to an unambiguous two per cent inflation target – no more clouding the issue with ambiguous language requiring it to also support “maximum sustainable employment,” such as the government pressured it into agreeing to in the last mandate negotiation – though he has added his own note of confusion by throwing asset prices into the mix, an idea we will no doubt have the opportunity to explore further at a later date.
But at least he is focused on things that are actually under the bank’s control. Mr. Singh’s objection, and that of his allies in the labour movement, that the bank ought to be less focused on inflation and more on fighting unemployment (the president of the Unifor union went so far as to accuse the governor of waging a “class war” against workers) is based on the belief that there is some tradeoff between the two.
In the short run, that may be true: Indeed, the governor has been frank that unemployment, currently at a 40-year low, will have to rise somewhat if inflation is to be tamed. That’s simply a recognition of reality: Wages make up 70 per cent of the final prices of things. So long as wages are rising at 5 per cent, good luck holding prices to two.
But in the long run, there is no tradeoff, as we learned in the 1970s. To hold unemployment to some arbitrarily fixed level requires not just higher inflation, but accelerating inflation. That’s not sustainable.
A final point. Is Mr. Poilievre right to point to the news that the bank will this year, for the first time in its 87-year existence, post a loss on its operations, as evidence of the unwisdom of quantitative easing? No. What it does show is the limitations of the policy.
The Trudeau government, recall, had been assuring everyone that it could take on virtually any amount of debt, not only during the pandemic but before and after, because of Historically Low Interest Rates. Not only did that mean low interest costs today, but it could “lock them in” by borrowing in the long end of the market.
It hasn’t quite worked out that way – the government’s annual debt service bill next year will be more than twice what it was two years ago – but even if it had, that’s only part of the story. Since most of the money the government borrowed by issuing new long-term bonds ended up on the Bank of Canada’s books, and since the bank bought the bonds, in effect, with money it borrowed short – those settlement balances it issued the banks – the government’s overall debt profile, consolidating its own books with the bank’s, was no less exposed to interest-rate fluctuations than before. As will become evident when the government covers the bank’s losses.
The bank’s bond purchases helped the government manage its debts in the middle of an economic crisis. It did not make them disappear.