The problem with Canada s monetary policy regime

The problem with Canada s monetary policy regime
Canada’s monetary policy regime works fine, by most accounts, but it’s not as credible as it could be. For example, in 2016, Stephen Poloz’s Bank of Canada and Bill Morneau’s Finance Department, after very little public discussion, decided to re-up the existing approach and lock in the two-per-cent inflation target for another five years. It was akin to a budget speech at midnight.

Democracies aren’t supposed to work that way. Don’t blame the technocrats; they were just doing their jobs. Those of us who make a living off the democratic ideal — cabinet, legislators, academics, reporters — were asleep at the switch. Most of the electorate probably had no idea monetary policy was even up for discussion.

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The Bank of Canada’s mandate is up for renewal next year, and this time will be different. The central bank for how an arm’s length Crown corporation should engage with the people it ultimately serves.

The economics academy has also stepped up. Université Laval’s Stephen Gordon and McGill University’s Christopher Ragan last month organized a conference on the 2021 mandate renewal hosted by the Max Bell School of Public Policy, which Ragan leads. The result: a trove of insight on monetary policy that is available to everyone with access to the internet. (Disclosure: I participated in a panel discussion at the conference.)

One nugget came from Angela Redish of the University of British Columbia’s Vancouver School of Economics, who zeroed in on how lower-for-longer interest rates have inflated asset prices, thereby widening the gap between those who are rich and/or lucky enough to own property and stocks and those who aren’t.

“Any monetary policy, and any implementation decision, has distributional consequences,” Redish said . “I would like to see a semi-annual report that talks about how monetary policy has had consequences for income distribution … some formal recognition by the bank that it’s decisions have consequences for income and wealth distribution.”

The subject of inequality tends to cause central bankers some discomfort. Their business was once simply to raise or lower interest rates, while distributional issues were less obvious. But the decision of the U.S. Federal Reserve, European Central Bank and Bank of England to embrace quantitative easing (QE) — creating money to purchase bonds and other financial assets — to fight the Great Recession made the side effects difficult to ignore. Arresting that downturn was good for everyone, but some did far better than others.

Canada avoided QE a decade ago, but as the lockdowns associated with the COVID-19 pandemic triggered the biggest economic collapse since the 1930s, the Bank of Canada became one of the world’s most aggressive users of it. Tiff Macklem, the governor, insists the jury is still out on whether monetary policy is widening the income gap.

“It is true that QE works through many channels, including financial portfolios, that may boost wealth inequality,” Macklem said in September. “But as research on the experience with QE in the United States and euro area highlights, QE can also reduce income inequality. We will continue to study and monitor all the effects of QE.”

That sort of equivocation will invite rough treatment the next time Macklem appears on Parliament Hill.

Conservatives are skeptical of QE. Opposition leader Erin O’Toole said in the manifesto that helped him win his job in August that the “massive amounts of money the Bank of Canada printed raise the risk of inflation and higher debt service costs.”

Pierre Poilievre, the party’s finance critic, has added another dimension to his boss’s critique, telling Bloomberg News in an article published on Oct. 15 that “expanding the bank’s balance sheet during a short-term, once-in-a-lifetime pandemic lockdown is different than perpetually buying and inflating the financial assets of the wealthy at everyone else’s expense.” He also said the Bank of Canada should “stay out of political and ideological debates and stick to its job, which is inflation targeting.”

The Max Bell School conference heard similar sentiments from participants who hold a more orthodox view of monetary policy. They fret that the public has come to expect more of central banks than the institutions can reasonably deliver. Democratic lawmakers in the U.S. this summer introduced legislation that would add reducing racial employment gaps and narrowing income inequality to the Fed’s mission. The old guard worries that such ideas could spread north.

“How far should we push the central bank?” asked John Murray, a former deputy governor at the Bank of Canada who is now an adjunct professor in the economics department at Queen’s University in Kingston, Ont. “I do worry that this is getting to be an ever-expanding list instead of minding your knitting, as my grandmother used to say.”

But what if Redish is onto something? The International Monetary Fund last month published a staff research paper that argues central bankers should make a point of considering inequality when they set interest rates.

Niels Jakob Hansen, Alessandro Lin and Rui Mano created a laboratory setting in which the business cycle was driven by technological innovation, which mirrors the economic growth dynamics of the past decade or so. A rich person owned the capital, and a poor person didn’t. Their model produced better outcomes when interest rates were lowered to boost wages than when rates were left higher due to a mechanical response to inflation.

One paper by a trio of younger researchers won’t — and shouldn’t — trump the concerns of a veteran policy-maker such as Murray. But there is a discussion to be had. The finance committee, of which Poilievre is a long-time member, was absent during the Bank of Canada’s last policy review. Time for it to wake up.
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