Canada’s new central bank chief faces bigger challenges than we realize

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Despite the awesome powers invested in the person who leads the country’s central bank, most Canadians do not know what that person does and most probably do not care. Their blissful ignorance spares the head of the Bank of Canada from much scrutiny.

The last Bank of Canada governor to wind up at the centre of a political controversy was John Crow, and that was almost 30 years ago. The knock against Mr. Crow was that his obsession with wrestling inflation to the ground helped create the conditions for a Made-in-Canada recession by strangling the manufacturing sector with a high dollar.

Jean Chrétien’s Liberals made Mr. Crow an explicit target during the 1993 federal election campaign. Mr. Chrétien even went so far as to suggest that, if he became prime minister, he would direct the governor, whose independence from the government is inscribed in law, to make reducing unemployment a top priority for the bank.

After the election, the Liberals replaced Mr. Crow with Gordon Thiessen. Mr. Thiessen had been Mr. Crow’s deputy and largely shared his philosophy regarding monetary policy, favouring low inflation and a stable currency. But the perception that politicians were pulling the strings undermined Mr. Thiessen’s ability to do his job.

The Canadian dollar began a steep descent that put the country on track toward a balance-of-payments crisis. Global investors feared the federal government would be unable to service its foreign debts. Market psychology violently turned against us.

“If you think the Mexican peso is North America's only basket-case currency, look again – north of the U.S. border,” the Wall Street Journal wrote in early 1995.

Mr. Crow ended up being vindicated. His steady hand and stiff determination had inspired investor confidence that monetary policy was in adult hands. The loss of that confidence in the wake of his departure forced Mr. Chrétien’s government to overcompensate by tabling a 1995 federal budget that slashed program spending and cash transfers to the provinces beyond what might otherwise have been needed. The cuts were so deep that provincial health care systems still bear their scars.

The lessons that emerged from Canada’s near-death experience in the mid-1990s were twofold. The first was that the financial markets will let you get away with running gargantuan deficits – until they don’t. The second was that an independent central bank that makes low inflation its all-consuming objective is in everyone’s best interest.

Since then, the Bank of Canada has maintained a formal policy of adjusting interest rates to keep inflation within a band of between 1 per cent and 3 per cent, with 2 per cent considered the sweet spot. Its job has gotten more complex since the 2008-09 financial crisis, when most central bankers cut interest rates to historic lows and keep them there.

Still, formal inflation targeting has largely kept the Bank of Canada governor off the front pages and out of the crosshairs of politicians.

Or at least that was the case until the coronavirus pandemic struck and Governor Stephen Poloz began implementing a kitchen-sink monetary policy that involves bailing out anything that moves. The bank is now even buying up Government of Canada bonds, an exercise that amounts to creating money out of thin air.

In a Monday speech, senior deputy governor Carolyn Wilkins did her best to justify these unprecedented moves, deeming them “consistent with our inflation objective because an economic recovery cannot be sustained without a well-functioning financial system.”

That’s true, as long as the extraordinary measures the bank is taking now to prevent financial markets from seizing up are unwound quickly once the crisis ends. But to the extent that the bank’s actions appear to blur the lines between central banking and politics, they could become a problem. By vacuuming up provincial government and corporate debt, while indirectly funding Ottawa’s current open-bar fiscal policies, the Bank of Canada is going far beyond its traditional mandate to support the economy.

Last week, Finance Minister Bill Morneau picked former deputy governor Tiff Macklem, who had been passed over for the governor’s job in 2013, to succeed Mr. Poloz next month. The word “challenge” does not begin to describe the task that awaits him. Financial markets have welcomed the central bank’s recent interventions. But those same markets could just as easily turn against Canada once the crisis subsides and investors focus on the country’s declining fundamentals. The Bank of Canada will need to stand tough to maintain its credibility and to avoid a currency crisis reminiscent of 1995.

Canadians should wish Mr. Macklem luck. He’ll be needing it.

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