THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Thursday, November 24, 2022
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 11:31 a.m. [ET] to study matters relating to banking, trade and commerce generally.
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Hello to everyone in the room and joining us online. Welcome to this meeting of the Standing Senate Committee on Banking, Commerce and the Economy. My name is Pamela Wallin. I am chair of this committee, and I will introduce other members of the committee with us today: Senator Gignac, Senator Loffreda, Senator Marshall, Senator Massicotte, Senator Ringuette, Senator Smith and Senator Yussuff. Thank you very much for joining us today.
We will continue our discussion on the state of the Canadian economy and inflation. On our first panel today, we have the pleasure of welcoming back Jack Mintz, President’s Fellow, University of Calgary’s School of Public Policy. Thank you for your patience. We know you tried to be with us on another occasion, and we had technical issues on our end. We really appreciate you rescheduling.
I will turn over the floor to you, Mr. Mintz, for opening remarks, and then we will begin our questioning.
Jack Mintz, President’s Fellow, University of Calgary’s School of Public Policy, as an individual: Thank you very much, Senator Wallin. I assume everyone can hear me fine, yes?
Thank you very much. In this very brief discussion, I wish to make four very simple points. First, it is important to understand that our recent inflation experience initially resulted from cost-push factors — health restrictions, supply chain disruptions, energy shortages and, now, labour shortages — and the government deficits accommodated this by a sharp increase in the money supply.
Western governments followed the same strategy of doling out government transfers in 2020 to avoid their economies from tanking. However, this led to households building up large savings that pushed up demand for goods and services that contributed to inflation. The United States and Canada spent so much in 2020 and 2021 that household incomes went up during a recession — 11% in the case of Canada — rather than falling with lost employment income. Overall, it was a successful strategy to avoid economic decline, but Canadians are now paying the piper through higher consumer prices.
Second, it is easy to blame external factors for domestic inflation, but they do not explain inflation experiences across countries. In particular, China, Japan, Switzerland and Saudi Arabia have inflation rates that have not gone above 4%. On the other hand, many countries are well higher than these inflation rates: Turkey at 86%, the Netherlands at 14.3%, Mexico at 8.4%, the United States at 7.7% and Canada at 6.9%. All these countries have faced higher energy prices, supply chain shortages, et cetera.
So other factors, including government fiscal deficits and accommodative monetary policy, played a role affecting the level of inflation. Canada is performing somewhat better likely due to recent monetary contraction, beginning the last half of 2021, that takes 18 to 24 months to be fully realized, at least as predicted by the Bank of Canada.
Today, Statistics Canada announced 995,000 job openings in Canada for a 5.7% job vacancy rate. This is my third point: As of October, the number of unemployed Canadians was 1.07 million. There is always some mismatching of demand and supply for labour skills — structural unemployment and some job vacancies — but labour markets remain quite tight. With rising interest rates, demand for goods and services will be cut back. Initially, we will see a decline in GDP. However, with excess demand for labour, unemployment is decoupled from output declines due to these labour shortages. Initially, labour markets will remain tight, labour incomes will improve, asset prices will fall, and consumer price inflation will be more stubborn before monetary contraction has its full impact.
In the case of cost-push inflation, I suggest that it will take longer for monetary policy to reduce inflation, although we need to understand this more in light of today’s factors.
Fourth: Why should we worry about inflation? Young people who did not experience high inflation in the 1970s and 1980s did not experience mortgage rates as high as 17%, the pain for those living on fixed incomes, food poverty, the deep recession in the early 1990s and rising taxes on nominal incomes due to unindexed taxes. The Bank of Canada is right to focus on price stability today by raising interest rates and halting quantitative easing. The bank erred in both 2020 and 2021 in failing to understand the implications of cost-push inflation, which was quite different than the 2008 financial crisis, which led to a fall in demand for goods and services. I think it is now incumbent on the bank and monetary experts to study the implications of cost-push inflation on the conduct of monetary policy, including interest rate targeting and quantitative easing. For this reason, I argue that an independent review of the Bank of Canada’s monetary operations should be considered, similar to the Australian review now being conducted.
Those are my remarks, Madam Chair.
The Chair: Thank you very much, Mr. Mintz. We really appreciate these insights.
Generally, we have heard a lot of commentary at this committee over the last few months that inflation in this country is homegrown, and you seem to be adding to that. There were other factors at one point, but not at this point, yes?
Mr. Mintz: What I am stressing is that, yes, there were cost-push inflation factors, just like we saw in the 1970s with OPEC, which led to a rise in oil prices at that time. However, in the end, what really matters is how fiscal and monetary policies act in terms of what the overall inflation rate is.
In fact, there was a very good study done by the Federal Reserve Bank of St. Louis in the summertime. I wrote about that study and used it in an article. They looked at 17 countries and they did find that the conduct of fiscal policy, particularly the size of the support given at that time, as well as monetary policy, did have some explanation or were certainly factors that explained some of the differences in the actual inflation rates across countries. Another important factor that they found, which I hint at here, is that countries tend to import inflation from other countries, and in particular, the very large packages of support given in the United States that led to its high inflation also contributed to our inflation here in Canada.
The Chair: Thank you. The job figures I’m sure we will come back to as well. Let’s begin our questioning with Senator Marshall.
Senator Marshall: Thank you very much, Dr. Mintz, for being here. I was going to ask you about the increase in money supply, but I saw an article this morning — I think it was in the National Post, and it says apparently Governor Macklem of the Bank of Canada testified at the Standing Committee on Finance over in the House of Commons.
He says that earlier lifting of pandemic stimulus would have contained inflation, which is — well, I found it surprising. The government is still spending, and it is not called stimulus anymore. They spent $100 billion in the budget year before last. Spending is still increasing, and they are still borrowing. Can you just talk about the impact of all this government spending? If you could also address the issue of tax increases because the government is also receiving a lot more now in income tax revenue, but they are spending that too, and borrowing.
Can you just round that out in a package and give us some comments on that?
Mr. Mintz: I often talk about fiscal policy. In fact, there’s a very interesting line of work that has been done by John Cochrane of Stanford University, who has been arguing that fiscal policy itself could create inflation, and that’s when you are running deficits, but it also impacts the way that people might view how things are going to evolve over time.
The main point is that government spending did go up quite a bit in 2020. We created a deficit so large that, just to put it in comparative terms, if we eliminated all federal taxes in 2015, not collected a single dollar, the deficit in 2015 would actually have been lower than the deficit we did create in 2020. That’s pretty astounding when you think about it.
Spending did go up more in 2021, as you pointed out. In the economic update, as we saw, the government got a huge windfall from the revenues that came in, a significant part of it due to inflation. When price levels go up, you are collecting more GST revenues, you are collecting more excise taxes such as fuel excise taxes and you are also collecting, potentially, more income taxes, because not quite everything is indexed. Also, the indexation factor for 2022 was only 2.4% when inflation has been rising at more like 7% or 8%. Even those with indexed incomes or indexed transfers from the government are still lagging. There is going to be some makeup of that in 2023. In 2022, they have not had their pension payments and their child benefits going up as much as inflation went up because of the way the indexation factors are calculated.
Overall, the government has had a lot of revenue coming in, and spending didn’t quite rise as much in 2022, so there was a significant reduction in the deficit of about — I forget the number now — but there was a significant reduction in the deficit. At the same time, the government spent half of the revenue windfall that came in.
So how much of a restrictive fiscal policy do we really have? I would argue that it’s not being restrictive at all right now, because we could have actually gone to an even lower deficit than what we’re doing in 2022. Fiscal policy is still not consistent with monetary policy. Monetary policy is focused on price stability, raising interest rates to bring down the rate of inflation, but fiscal policy at the federal level is not being sufficiently consistent with our aims of monetary policy. That is an issue that needs to be thought about.
Senator Marshall: The way I look at it is the Bank of Canada is working at cross purposes with the government. The government is spending, and the governor of the bank is trying to control inflation, but the government is really not helping them very much by accelerating their spending.
Mr. Mintz: That’s exactly the point I am making.
Senator Smith: Good morning, Jack. It’s good to see you.
Mr. Mintz: Thank you.
Senator Smith: You noted in a recent article that Canada should keep an eye on carbon policies enacted in the United States and how a high carbon tax coupled with low subsidies could prove detrimental to our manufacturing and technology sectors given the very different approach to carbon policies south of the border.
Could you please explain why the different approaches to carbon policies in Canada and the United States reduce our competitiveness and how that poses a risk for manufacturing and clean technology here in Canada?
Mr. Mintz: The key issue is that the U.S., certainly at the federal level, is not bringing in carbon pricing. There is some carbon pricing, cap-and-trade systems, of course, the most important one being in California. The only ones that are happening are at the state level, which are relatively low in their overall impact for the economy in the United States. Instead, the Inflation Reduction Act in the United States is really focused on subsidies for green energy. They are really very generous.
To give you an idea, they are turbocharging carbon capture, utilization and storage, or CCUS. There is a US$185-per-tonne credit if there is no enhanced oil recovery. If there is enhanced oil recovery involved, it is US$135 a tonne.
On top of that, the projects can claim carbon credits and other things. There is a huge amount of money that’s going to go into carbon capture utilization and storage. In Canada, we’re looking at an investment tax credit that’s roughly 50% of the cost, but not nearly as competitive as what the U.S. subsidies are going to be. On top of it, we don’t even allow for enhanced oil recovery, unlike the United States.
When you look at CCUS, and your company is looking at carbon capture and sequestration in Canada or in the United States, right now, it is obvious what the choice will be. It will be the United States.
Similarly, as I pointed out in that article, if you are going to build a lithium plant in British Columbia or a lithium plant in Arizona or Nevada — in Arizona and Nevada, mining taxes now are about as competitive as the Canadian mining taxes, and the corporate income tax in the U.S. is about as competitive as the Canadian one when it comes to mining operations. In fact, the Canadian mining and corporate taxes are pretty competitive by international standards.
I have been working on this quite a bit lately, in the past couple of years — in fact, this coming week, I am going to Washington to speak at the Inter-American Development Bank on work that we have done on Latin American and Caribbean mining taxation.
But the one big difference between Canada and the United States is the carbon tax. We are going up to $170 per tonne. In the United States, that won’t be happening. As the PricewaterhouseCoopers, PwC, study showed, once you include the carbon tax, it is better to build the lithium plant in the United States, in Arizona. This is an issue I will be spending more time on because our methodology is somewhat different than what PwC has done, but I do think that they make a very important point, and that is, we may find our manufacturing, our forest sector facing higher costs associated with carbon pricing, but then, at the same time, the green energy investments will be very attractive in the United States due to the turbocharged subsidy system that’s now operating in the U.S.
Senator Smith: Right now, many countries have little faith in the carbon tax, even here at home. As you mentioned, the carbon tax of $170 per tonne of greenhouse gases, or GHG, would not meet our climate targets. While other countries are skeptical, our government continues to argue for it. Could you explain the impacts of lack of global coordination on carbon pricing on the Canadian economy and why it is a major risk?
Mr. Mintz: It is very interesting. First of all, I believe the most efficient form — if you are going to try to control emissions for GHG — is carbon pricing. It could be a cap-and-trade system or a carbon tax, and one could get into a debate about which is the better one. In Canada, we’re not just doing carbon pricing; we’re doing subsidies, mandates and all sorts of things.
When you look at the carbon pricing across the world and you ignore fuel excise taxes — the OECD study not only looks at direct carbon taxes and emission trading revenues but also includes fuel excise taxes. I think the latter should not be included because that is not a proper carbon-pricing scheme, nor was it ever designed to be. It has been around for decades. It’s really designed to fund highways and roads, which will be an issue down the road.
My main point is that when you actually just look at emission trading plus carbon pricing across 71 countries, it’s less than €5 per tonne. That’s not very much. We are going to go up well above other countries. In fact, we’re already close to €20 per tonne — I think a bit less than that — so we will be having a much higher carbon price than most countries in the world. At the same time, as we saw with the United States, they are going into a completely different route.
Senator Gignac: Nice to see you again, Jack. In your article — I think it was the day after the economic update from Ms. Freeland — your article in the Financial Post was entitled “Trudeau follows Biden down the path to economic ruin.”
Could you elaborate a little bit on why we are going to the basement with this kind of policy?
Mr. Mintz: Well, I have to admit that I do not write the titles to my articles. That’s usually the editors, who are trying to sell newspapers, so that wasn’t really my title. In fact, if you read the article, I never quite said that. The main point of the article is to say that we are still in a path of spending. We are not seriously thinking about the implications of deficits on inflation, productivity. In fact, I would argue that, right now, some of the Biden plan is very similar in that way.
Senator Gignac: Feel free to send information in writing, if you like. I understand you have a cold.
Basically, you mentioned in other articles that you have identified five reasons why inflation will persist. Among them, one is regarding the fiscal policy — that the current spending does not help. You can reply in writing or now if you have time to summarize.
Mr. Mintz: My main point is that the spending is primarily being spent on transfers and subsidies with respect to the green economy, but we have a serious problem vis-à-vis productivity. In fact, what also concerns me are the rising taxes that we are starting to see, especially in corporate taxation but also in personal taxes, et cetera. I think we need to worry a lot more about productivity. Right now, the response of the current federal government, and also the Biden approach, has been to use government business subsidies to promote certain industries, but I don’t think that’s necessarily the best approach to rely on.
While we have serious issues around regulation and taxation that need to be addressed, we need to help encourage more productivity overall in the whole private sector, not just certain politically favoured activities.
Senator Loffreda: Thank you, Mr. Mintz, for being here with us. I have in front of me and I read the article “The demographic time bomb has arrived.” You make some strong statements there, which I won’t go into. You make a strong point that, unlike interest rates or weather, long-term demographic trends are highly predictable, and we are facing a demographic storm that will have far-reaching impacts on the economy and geopolitics. Do you feel that Canada’s current immigration strategy, policies and regulations will be sufficient to fully mitigate those risks, or do we risk long-term inflationary effects given our current housing crisis and other factors that influence inflation?
Mr. Mintz: Some people think we can deal with economic growth by simply bringing more people into the country. While I am very positive about the important long-run effects of migration coming into the country, my point on the demographics is that all high-income countries and many large upper-income economies, such as China, Brazil, et cetera — all of them are facing rapid-aging problems over the next 13 years.
As a result, international markets for labour are going to be much more competitive. The effect is a predilection for people willing to remain home, where their families are, rather than going to another country. It’s only when they’re facing political difficulties or poverty that populations will shift. But we are all going through the major rapid-aging problem. As a result, immigration will be tougher, especially for skilled immigrants, over the next number of years.
The best response or one of the most important responses to our demographic problems — and there are some positive things, I mean real wage rates will go up as you have insufficient people in the labour force and still rising demands — if you want to remain competitive as an economy — and I think rising wages are a good thing, not a bad thing — you are going to need capital investment.
Canada has done a very poor job on capital investment. In fact, in a paper with Phil Bazel last year we showed that from 2015 to 2019 there were only four countries in the world that actually had a reduction in capital formation. This is not just businesses but also households and governments. They were Canada, Mexico, Brazil and Australia. Partly driven in the case of Canada by oil and gas, but not entirely by oil and gas —
The Chair: I will have to stop you there, Jack, but we will find that paper and table it here.
Senator Ringuette: Good day, Dr. Mintz. Nice to see you again. When you talk about the fiscal policy and government spending for 2020 and 2021, I see government spending as investing in survival during the COVID period. How shall I say it? To explain your stance in regard to government spending and fiscal policy during these budget years, which one of these COVID programs would you have not provided to Canadians?
Mr. Mintz: Well, I won’t mention WE Charity, but that was certainly one. First of all, whoever heard, during a recession, of household incomes going up by 11%? That means the average person was making 11% more during the COVID period than they would if there were no COVID, compared to the year before. That’s really very unlikely to happen. In fact, in Germany, that did not happen. Household incomes stayed flat. My main point was there was too much spending, excessive spending, even though we did require spending to deal with the pandemic. I’m not saying we should have had zero spending.
Take, for example, the Canada Emergency Response Benefit, the CERB, which was very expensive. We didn’t differentiate between full- and part-time workers, and the amount of money given to part-time workers was far more for many of them than what they would make if they were working. We did rush out the money; I know that. But it came at a huge cost, and we have to remember that.
Senator Ringuette: The issue of survival was based on, in your terms, whether they were working full-time or part-time?
Mr. Mintz: No, it’s just an example.
Senator Ringuette: Excluding trying to survive.
Mr. Mintz: You could have had a lower amount given to a part-time worker than a full-time worker, as an example. There were a number of things in the spending that were way too much.
Senator Yussuff: Thank you, Dr. Mintz, for being here.
I want to go back to the whole question of inflation. Clearly, the challenge we face as a country in dealing with inflation is that we don’t grow a lot of vegetables except for the summer, so a lot of these products is coming from the U.S. and other places. The exchange rate is part of the problem, but equally if we’re importing this, we don’t necessarily control prices, fluctuation in the market and the exchange rate. Would you not agree that this is contributing significantly to the challenge we face until we can get the product we are purchasing, but equally our exchange rate that is not so obviously dependent on what we buy from other markets in terms of dealing with inflation?
Mr. Mintz: Just as a quick reminder, a short piece, which I assume can be read by the committee, that I read earlier on. Everybody faced higher food prices around the world, but it still doesn’t explain the different responses.
In the case of China, there was not as big of an amount of spending that went on to deal with COVID. They didn’t go into a major program of spending. They didn’t set up monetary policy and fiscal policy that led to high inflation. The reason I’m saying that is suppose you did raise interest rates earlier on; that would have pulled up the Canadian dollar, allowing import prices to come in at a lower price. We should quit focusing simply on certain products and relative prices, and enrol monetary policies to control the overall price level, the nominal price level. We had a monetary policy that accommodated a lot of the spending, but it was also slow in reacting. Very little was done in 2021 until toward the end of 2021 because the bank, quite erroneously, expected inflation to fall more quickly.
The Chair: Mr. Mintz, I know you have to rush off. Have you got one minute for Senator Massicotte, or should we wrap this up?
Mr. Mintz: No, I’m okay.
Senator Massicotte: Nice to see you again, Jack.
Mr. Mintz: Thank you.
Senator Massicotte: Talk to me about the productivity. You said no investment or a very poor level of investment. A consequence of that is we’re suffering from poor productivity. Any comments on what the solution could be to get us out of this tough situation?
Mr. Mintz: Well, first of all, we really do need to look at our regulatory policies both at federal and provincial levels to see which ones are leading to, for example, very slow permitting. It’s going to be very important in the green economy as we go through this energy transition, being able to build transmission lines or redoing pipelines or whatever kind of expenditures that we’re going to need to build up new energy systems. As we know from many studies that have been done internationally, Canada actually has a very poor performance in permitting. This is a very significant issue that needs to be dealt with by federal and provincial governments; otherwise, we are going to be having a lack of investment. There is no question in my mind that this has been one of the important barriers to investment that’s happened here in Canada, where our real investment has declined in dollars — not just relative to GDP, but declined in dollars — since 2015. That is one area.
With respect to tax policy, we have undertaken corporate tax reform since 2000. We got our system from being one of the highest effective tax rates on capital to the middle of the pack. It has crept up since 2012. Perhaps we need to think a little bit more about our overall tax structure. We’ve raised top personal rates to over 50%. That has led to significant discouragement of entrepreneurs and others to work in Canada. We have capital that’s flowing out of the country more so than we have capital coming into the country. There are a number of things to work on, but the most important is to say that Canada is open for business.
Even the carbon policy that we have, the carbon tax, the revenues have been returned to the households as lump sum transfers, and there’s very little relief given to businesses, which are actually facing these higher carbon prices and costs as a result, making them uncompetitive. We need a lot more attention paid to business investment than what’s currently being done.
The Chair: Thank you very much. Again, we apologize for having to reschedule your appearance, and we appreciate your time today and your being with us from Calgary. We will suspend, ladies and gentlemen, just while we have our next witnesses connected by video.
Mr. Mintz: Thank you.
The Chair: We will continue with our discussion on the state of the Canadian economy. We have with us by video conference for our second panel today Mr. John Greenwood, Chief Economist with International Monetary Monitor Ltd., and Mr. Steven Ambler, Associate Professor at the Université du Québec à Montréal and David Dodge Chair in Monetary Policy at C.D. Howe Institute.
We’re going to begin with an opening statement from Mr. Greenwood, followed by Mr. Ambler.
Mr. Greenwood, please go ahead.
John Greenwood, Chief Economist, International Monetary Monitor Ltd., as an individual: Thank you, Senator Wallin. Thank you, senators, for inviting me to testify here today.
I’m going to abbreviate my opening remarks, which I timed at nine minutes. I’ll try and keep them within five. I want to cover three topics: first, the most appropriate monetary policy for Canada; second, the origins of the current inflation; and third, how you can avoid repeating such an episode in the future.
First, the most appropriate intermediate target for monetary policy is for the central bank to focus not on interest rates, but on monetary growth, and by that I mean the broadest measure of money that is available, which is M3 in Canada.
The next question is at what growth rate should that be allowed or encouraged to grow. In different countries, the answer will vary, depending on the sum of three magnitudes: the sustainable or potential real GDP growth of the economy; the rate at which the population wishes to add to its money balances relative to income year by year; and third, the inflation target. In Canada, these figures are approximately 2% for real GDP growth, 1.9% per annum via addition to money balances, and 2% for the inflation target. If we round up slightly, these figures give us a required or optimum rate of growth of broad money of 6% per annum.
Now, during the period 2009 to 2019, M3 growth was just slightly greater than this, averaging 6.5% per annum, and as a result, Canada’s CPI inflation rate averaged very close to the 2% target, at 1.7%.
I want to stress that the monetary target should not be allowed to become a fetish. As long as M3 growth is within a few percentage points on either side of that 6% intermediate target, no great harm will be done.
Second, what happens when this intermediate target for M3 is ignored for any extended period? I want you to consider two periods: first, the decade of 1972 to 1981, and second, the COVID period.
Now, in preparing these remarks, I read very carefully the testimony of the Bank of Canada Governor Tiff Macklem when he appeared before this committee on November 1. He said, in answer to a question from Senator Gignac, that in the 1970s, “we looked at money supply every week.” That’s a mistake, in my view. And “we learned that the relationship between money supply, inflation and the economy wasn’t consistent.”
This is simply disingenuous. The average rate of growth of Canadian M3 during the decade of 1972 to 1981 was 17.4%, almost three times the 6% that I just mentioned. It was hardly a surprise, then, that inflation in the years 1973 to 1982 averaged 9.6% per annum. It was clearly inadequate monetary control.
The second period to consider, and much more relevant, is the pandemic, specifically 2020 and 2021. During these two years, the Bank of Canada purchased Canadian government bonds on a large scale. According to Governor Macklem’s testimony:
QE basically provides a different way to lower interest rates further at the yield curve. . . . QE is just another way of lowering interest rates.
What he failed to mention was that when the Bank of Canada purchased those Canadian government bonds, those purchases were paid for by cheques from the Bank of Canada direct to the sellers, adding directly to the money supply M3. As a result, M3 accelerated from 7.8% in January 2020 to 16.3% by June 2020 and remained at an elevated 12% level until February 2021. It’s that surge in broad money in M3 which is directly responsible for your inflation in Canada today, not the supply chain problems, not the energy price increases and not the food price increases, which are also widely blamed, and nor, incidentally, the fiscal spending, which we’ve heard so much about in the previous testimony. These are symptoms, if you like, but they are not causes.
How do we know this? Because as Professor Mintz correctly said, if you look at China, Japan or Switzerland — all countries that suffered the same supply chain problems, the same food and energy price increases as Canada — none of them has experienced a significant inflation problem. In all three countries, money growth was kept under control, and that’s the reason why they have escaped with no inflation or a negligible increase in inflation.
Third and finally, how can Canada avoid repeating such a painful episode? My suggestion for Canada is that you legislate to revise the Bank of Canada’s mandate, adding an overrider to the inflation target that would require the Bank of Canada to keep M3 growth within some broad tram lines, say 3% to 9%, but centred on the 6% target that I mentioned earlier.
Again, this is not to be followed blindly week by week or even month by month. Nevertheless, money growth should not be allowed to deviate outside these limits without the governor and his policy committee being hauled over the coals.
To close, allow me to leave you with this quotation from Milton Friedman:
Monetary policy is not about interest rates. Monetary policy is about the rate of growth of the quantity of money.
Thank you.
The Chair: Thank you very much, Mr. Greenwood. Those were very insightful comments.
We’ll go now to Mr. Ambler for his opening comments as well.
Steven Ambler, Associate Professor, Université du Québec à Montréal and David Dodge Chair in Monetary Policy, C.D. Howe Institute, as an individual: Thank you very much, Senator Wallin, for the opportunity to speak before this committee. I want to talk about three or four points. I’ll try to get through them very quickly. I prepared a written statement.
[Translation]
I didn’t have time to translate it, so it has not been sent to the senators.
[English]
The Chair: Please send that along to us.
Mr. Ambler: I have already sent it to your clerk. There are one or two typos, so I will send a revised version.
Talking about inflation first, I have a slightly more optimistic message. The measure that everyone looks at and gets all the attention is headline inflation, which was 6.9% in October, which is persistently high. That is the increase in the Consumer Price Index over the last 12 months, so it includes price increases which took place more than six months ago. I think that month-over-month inflation gives a better idea of where we are now and where we are headed. Also, looking at what the Bank of Canada calls its core inflation measures, which abstract from the more volatile components, is a better predictor of inflation over the near term.
If you look at that, CPI-trim — the three-month averages at least — in May, it was 7.8% — high. In October, it was already down to 3.4%, based on the latest numbers available. The CPI-median was running at 7.4%, the same three-month averages, and is now down to 3.3%. Both of these are not far from the upper end of the Bank of Canada’s target range and they are moving down rapidly, so this is encouraging.
Now, when John Greenwood talked about money, and I’m going to talk about it as well — I have a paper, Ambler and Kronick (2022), which argues that when inflation is close to target and stable, the money supply actually is a poor predictor of inflation. If you’re hitting your target, the best predictor of inflation is the target. But when it’s not, like now, looking at money is an important indicator.
Once again, if you look at what’s happening more recently to money, Mr. Greenwood talked about what happened in 2021, excessively high rates — [Technical difficulties]
The Chair: While we attempt to resolve our technical problem with Mr. Ambler’s connection, we will begin our questioning with Mr. Greenwood.
Senator Loffreda: It’s too bad we weren’t able to complete Mr. Ambler’s remarks, but I see that you do have opposing views.
Mr. Greenwood, I was very interested in reading your article “To understand and forecast inflation, follow the money” and to hear your remarks. Very insightful. Thank you. In your article, you conclude that inflation could accelerate again in mid-2023 and continue well into 2024.
Maybe we can have remarks from both our panellists if possible. Many are predicting a recession, including some of the major banks, as early as Q1 in 2023. There is a consensus that it will be a mild recession, so many entrepreneurs and businesses are preparing for a mild recession in Q1 of 2023 or during 2023.
Can you elaborate on your projections and thoughts given your views on inflation? Also, when John Crow was the Governor of the Bank of Canada from 1987 to 1994 — and I was just looking at some statistics in the 1990s and the difficulties that Canada’s economy had in recovering — they were looking at money supply. I think for the Governor of the Bank of Canada, Mr. Crow at the time, money supply was a priority, yet we didn’t perform much better than other nations. Can I have your comments on both those thoughts and views? Thank you.
Mr. Greenwood: Sure. Thank you. Well, first of all, on the projections, that was a conditional projection. If the money supply continued to accelerate — as it was doing at the time but has ceased to do — then I think it was legitimate to say that inflation could turn up again.
Second, inflation tends to lag by anything up to two years and sometimes more. That was the reason for saying that inflation would continue in through 2023 because, in 2021, Canada had very rapid money growth. Two years later would be 2023, and there could be spillovers into 2024, and that would be exacerbated if money accelerated in the meantime. But, as I say, that danger has diminished recently.
As to the record in the 1990s, I think you’re talking mainly about the early 1990s, when the U.S. was also struggling with growth, and Canada was very significantly influenced by that. Central banks can do very little about the real growth performance. What they can do, though, is to manage money and therefore inflation. I think that John Crow’s record on that was good. He used to say, when asked whether money featured in their models at the Bank of Canada, that it didn’t feature, but that he made sure to look over his shoulder at what is happening to money to make sure that it’s neither excessive nor inadequate.
The Chair: Thank you very much.
Senator Marshall: Can you talk about your article of August 8, 2022, in the Financial Post where you referred to the “politically determined policy of the Bank of Canada”? I think you were referring to all those government bonds that the bank bought. Most of them are still on the bank’s balance sheet. Can you comment on the implications?
I think the bank’s independence is being questioned now by a lot of people. The fact that they’re holding those bonds on their balance sheet sort of supports that opinion or that concept. Why can’t the Bank of Canada just sell those bonds or sell some of them? Because there are implications to holding those bonds. We know now that the Bank of Canada will start incurring losses in the next quarter as a result of the low interest that the government is paying on those bonds. Why not sell off the bonds and try to preserve the bank’s independence?
Mr. Greenwood: Okay, first of all, that phrase “politically determined” was not my phrase. My co-author was Herbert Grubel, someone who is probably well known to you. He insisted on putting in that phrase. My own view is that what matters is how much money is created by central bank operations, by purchases of bonds, whether they’re corporate bonds or government bonds or whatever.
Most central banks try to keep that fairly neutral by buying government bonds. It’s the amount that matters, rather than the type of bonds, because when a central bank purchases bonds, if it buys them from non-banks, as in the case of the Bank of Canada, effectively it’s writing a cheque to the seller. That seller then receives new money that’s in addition to the money supply in the banking system, so the money supply has gone up. It wouldn’t matter whether that was a corporate bond that the Bank of Canada had bought or a Canadian government bond or, indeed, a second-hand car. All of those would result in a payment of a cheque to the seller, and that would increase the money supply.
Normally, central banks don’t get involved in creating money like this. If you take the period from 2010 to 2019, the Bank of Canada’s contribution to money creation was negligible. It’s only in times of emergency, when they do this quantitative easing, or QE purchasing, that they create money. What is more important is the amount of money they create, rather than the instruments they use. Thank you.
Senator Marshall: Do you think that the bank should start to sell off those bonds?
Mr. Greenwood: Well, if it sold them off rapidly, that would have the opposite effect to what happened when they purchased them. When they purchased them, that increased the money supply very rapidly. Conversely, if they were to sell them off rapidly over the same sort of time frame as they acquired them, that would make for a negative contribution to money of the same order of magnitude. That would be, I think, very dangerous or very damaging to the economy.
It doesn’t work quite so directly on the sell side in quantitative tightening, or QT, because, typically, when the bonds mature, they get cancelled from the government’s account at the Bank of Canada, and the assets obviously disappear from the asset side of the balance sheet. But, in principle, it’s the same. The result is slower growth of money.
You have to be more careful when you’re selling government bonds as a central bank to make sure that there isn’t an excessive stringency imposed on the money markets.
Senator Marshall: Thank you.
Senator Gignac: Welcome, Mr. Greenwood. Thank you for referring to my discussion with Governor Macklem regarding the period of the 1970s. Could you elaborate how, this time, the QE and all the accelerated money supply compare to the last financial crisis? In the last financial crisis, central banks proceeded with QE as well, but they did not use corporate bonds. This time they have been backstopped on corporate bonds, which was a precedent.
So why this time the QE and money supply growing, accelerating — according to your point of view at least — is the source of the inflation, but in the last financial crisis they proceeded with QE, but it did not translate into our inflation. Could you discuss the divergence and the convergence between the two periods?
Mr. Greenwood: That’s an ideal question. Thank you for asking it.
Of course, in the period of the global financial crisis, the previous crisis, Canada was not so badly affected. Its banks were in reasonably good shape. So Canada had to do much less with that central bank support of the financial monetary system.
But if we take the cases like the U.S. and the U.K., the big difference is that, then, the banks were in very poor shape. They had large losses from their holdings of subprime securities. Then they had loan losses. On both accounts, they needed to recapitalize.
Now, when banks are recapitalizing, they cannot create loans at a rapid rate and, therefore, the stock of money, which is the deposits that are the counterparts of the loans, don’t grow.
So following the global financial crisis, if you take the example of the United States, bank lending declined by almost a trillion dollars, 14%. If the Fed had done nothing, the money supply would have gone down by 14%. That would have been a major disaster.
The Fed did QE. Essentially, it filled that hole. It prevented the money supply from contracting, but it didn’t do so much as to create inflation. It enabled money to grow at a normal sort of rate.
This time, the banks have been in good shape during COVID-19 and have been positively lending, both in the U.S., the U.K., Canada and elsewhere. Then, on top of that, the central banks poured a whole lot more fuel in the shape of QE, so money growth was much more rapid. That’s why we have had inflation this time and not last time.
Senator Gignac: Thank you. That was explained well. I share your analysis on that completely.
The Chair: I don’t know if you were listening to the testimony of Dr. Mintz, whether you could hear that, but he talked about the overstimulation, the overpayment throughout the pandemic; that people most certainly did need help, but when incomes rise 11% during a crisis, obviously there was some excess spending. He explained a couple of examples: that part-time workers were paid the same as full-time workers, et cetera.
Mr. Greenwood: Sure.
The Chair: We know the impact. One of those things is, as you say, inflation. We have also seen people leaving the workforce as a result of it. What is the short-term and long-term consequence of this?
Mr. Greenwood: The way to think about government spending is how it is financed.
Professor Mintz also said, and he quoted Professor Cochrane at Stanford, in saying that fiscal spending creates inflation. That is simply not correct.
Look at the example of Japan. Japan has had huge deficits through the 1990s and the early 2000s, but all the time they have had deflation. Why? Because they didn’t finance it by the printing of money.
Now, fundamentally, there are only three ways to finance a deficit. You can increase taxation, in which case the private sector has less to spend, and the government has more to spend. The second way to finance it is by borrowing. If the government borrows the money from the private sector then, again, the government has more to spend, and the private sector has less. The size of the cake has not diminished, but the government is taking more of it.
The third way to finance government spending — we use metaphorical language here — is to print the money. To print, that is to accompany this increase in government spending by a more rapid increase in the rate of growth of money; that’s exactly what’s happened in numerous countries during the pandemic period.
But for clear understanding and thinking about this, they were two separate operations. Governments undertook a lot of borrowing. Central banks increased money by buying government bonds in the secondary markets. They didn’t buy directly from government. These were two separate decisions.
As we’ve seen from examples quoted earlier, countries like Japan, Switzerland or China didn’t finance the government expenditures by printing money and, therefore, they haven’t had inflation.
The key is not so much the nitty-gritty details of how the government is subsidizing one group versus another but, more importantly, whether or not overall government spending is being financed by taxation, by borrowing or by the printing of money.
The Chair: Thank you. One more follow-up on your comments on legislating a revision to the Bank of Canada mandate in response to what we’ve witnessed here. You have talked about targeting. Can you flesh that out for us?
Mr. Greenwood: Yes. While we all need our central banks and monetary policy to be independent — independent of politicians and independent of the political cycle — the fact is that we’ve given too much discretion to our central bankers. We need to constrain them, not only with an inflation target but also by imposing on them a requirement that they do not allow money growth either to be too high for too long or to be too low for too long. Either of those two things can create problems for the economy. We need that additional rider on the inflation target.
The inflation target is mandated, but there is no discussion or constraint on what the central banks may or may not do to achieve that target. That’s the source of the error this time.
As I mentioned in my opening remarks, Governor Macklem said, “Oh, well, we’re just lowering interest rates.” Not at all. He was pumping up the quantity of money very rapidly, and that was the mistake.
The Chair: Thank you very much.
Senator Ringuette: Your perspective is very interesting.
When the Governor of the Bank of Canada was here, I asked him a question in regard to how high he can set an interest rate without triggering or contributing to a recession in Canada. I didn’t get an answer. I would like to know what your answer would have been.
Mr. Greenwood: Sure. In my view, that’s an unanswerable question, and the reason is this: What drives spending and, therefore, the question of whether or not Canada has a recession, is the rate of growth of money in prior periods.
If the rate of growth of money were to slow down to, let’s say, 3% or less and stay at that very low level, then I’d be quite confident in forecasting that Canada would probably have a recession. The inflation rate would fall quite sharply after a period of a year or two.
There’s no precise relationship between interest rates and a recession. You see, when the central bank raises interest rates, that tightens money in the first instance. Then what happens is the economy, after a while, slows down, and eventually inflation comes down. Then what happens is that interest rates fall.
There is a two-stage effect on interest rates, of changes in the rate of growth of money. The first effect of tight money would be to raise interest rates. The second effect would be to lower them.
It’s very difficult to say or, as I said, almost impossible to say precisely how high rates need to go because interest rates are a symptom of different things. High interest rates can be a symptom of very tight money, or, in other economies, if you’ve had a very rapid rate of growth of money — think of Argentina or Turkey or Venezuela — then you can have high interest rates because money growth has been excessively rapid. So interest rates are not a good guide to conducting good monetary policy. It is much better to rely, as I started out my statement saying, on the rates of growth of broad money. Then you won’t go too far wrong.
Senator Ringuette: Essentially, what you are saying is that by not increasing or decreasing the interest rate or keeping it at a stable rate and letting the economy grow, that inflation should therefore stabilize?
Mr. Greenwood: My answer is more that it’s desirable to maintain a steady growth of money. If that means some months you have higher interest rates, and other months you have lower interest rates, so be it; the important thing is not to allow money growth get out of control. The emphasis should be on the money, not on the interest rate.
The Chair: So we are hearing this debate, both in this country and perhaps louder in the U.S., that as the interest rates go up, of course, that’s going to increase recessionary pressures, which in turn brings interest rates down.
Mr. Greenwood: Ultimately, yes. The U.S. has a separate and more difficult problem to deal with right now, and that is that during the COVID period, their broad money grew at roughly 18% on average. Since the beginning of this year, that has slumped to zero. We have the prospect of a very sharp slowdown in economic activity.
If you would like me to put it in terms of a metaphor, the Fed stepped too hard on the accelerator during the COVID period with 18% average broad money growth, and now it is stepping too hard on the brake with sharp rate rises and QT, and that’s giving us zero growth of money in America in the first 10 months of this year. That threatens to produce a more severe recession and higher unemployment than is necessary to bring down the inflation rate.
The Chair: Thank you for that.
Just for the information of our committee, we are not able to re-establish our conversation with Mr. Ambler to the degree that the translators would be able to translate that. Does anyone have a final question or two for Mr. Greenwood?
Senator Smith: Sir, Australia is considering an independent review of its central bank. There are talks that the new U.K. prime minister has promised a review of the Bank of England’s objectives. Do you think that the Bank of Canada’s mandate should be independently reviewed, considering its actions over the last three years? What I am getting at is how we keep the central bank accountable yet maintain its independence.
Mr. Greenwood: As I said in my remarks earlier, the inflation target is the right thing to do, but it needs a little bit more managing of the means by which the central bank will reach that inflation target. By leaving the field wide open, countries across the world — the U.S., the U.K., Israel, eurozone, Australia, New Zealand and Canada — have all had excessive growth of money. This would not have happened if the mandates had been more tightly written to prevent this kind of excessive growth of money.
It’s a longer story than we have time for, but basically, the central bankers of the current generation ignore money and focus on interest rates, and that, in my view, has been a mistake. As I say, we don’t have time to discuss that. We need to get back to the simple truth that too much money chasing too few goods is going to produce a problem. That’s exactly what has happened in the last two years.
Senator Smith: Do you see a review process being implemented throughout the world by countries with their central banks as a result of what we have been discussing today?
Mr. Greenwood: It is possible there could be some reviews in different countries. The Fed has just conducted its own review of its performance, and the European Central Bank, or ECB, followed, and they did a similar review of their operating framework. Ironically, since doing those surveys, inflation has been let loose. I would not be confident of getting a good result from those kinds of reviews. I suspect that we would get more of the same and not the kind of detail that I’ve tried to give you in my testimony today.
Senator Smith: Thank you, sir.
The Chair: Just on that question of the review process, I think there are no outsiders involved in the Bank of Canada process in terms of assessing whether they are on the right track, whether it’s working, et cetera. When you talk about a review, how do you see that? What is the structure?
Mr. Greenwood: That’s exactly the problem. Too often, central banks get to mark their own homework. That’s what the Fed did. That’s what the ECB did. It’s the reality that a lot of the expertise resides at the central banks. That’s a powerful argument that has to be overcome, but, in my view, they’ve made mistakes in the last two years, two and a half years, and these need to be corrected.
Senator Loffreda: If we look forward to future strategies to be adopted by our central banks, given our geopolitical challenges currently — wars, climate challenges, harvest failures, epidemics — hopefully we won’t have many of those — do you feel that the supply shortages could only cause temporary inflation by these events? Your conclusion is that there should be greater focus on money supply; do you still feel that given the environment we are experiencing today and the uncertainty around us? Do you think that central banks should strictly focus on money supply? Obviously, we could be more agile in bringing support where it is required, but I’d like to have your thoughts on that.
Mr. Greenwood: Yes, Senator Loffreda, you are essentially talking about the difference between relative prices and the overall price level. Again, Professor Mintz briefly mentioned this in his remarks — correctly, I think — that it is within the central bank’s ability to control the overall level of prices through managing money. What happens to food prices by dint of bad harvest or to energy prices because of wars and sanctions, or what happens to the climate and therefore prices of some items in the economy, those are all things that are beyond the control of the central bank.
The central bank can really only deal with the simple notion of keeping the overall price levels stable. If there are these kinds of supply-side or even demand-side shocks, the central banks should really persist with keeping money growth stable.
If they had done that in 2020, in the face of COVID, and Canada had continued with roughly 7% to 9% money growth as it had at the time, you would not have the current inflation. So, in my opinion, yes, the world is facing lots of challenges, but these are not challenges that can be met by any policy of the central bank.
Senator Loffreda: Thank you.
Senator Gignac: Correct me if I am wrong, but if you check on the money supply comparison between the U.S. and Canada, that would suggest that, in fact, inflation in Canada in the coming years should be higher than in the U.S. What amazes and confuses me is why in the Canadian bond market, if you use the 10-year treasury bond in the U.S., for example, it is 70 basis points higher than in Canada. So it’s 3% at 10-year maturity in Canada, the Canadian bond yield. In the U.S., it is 70 basis points. The bond market could be wrong, but as a former portfolio manager, I say always listen to what the market tells you because it’s always a risk to ignore it. Why are the investors so confident about the inflation trend in Canada if the current money supply is so high? I have difficulty reconciling both.
Mr. Greenwood: Senator Gignac, I respect your knowledge as a former portfolio manager; however, as you rightly say, bond managers and other portfolio managers are not necessarily right. However, in this case, what we have had is very rapid growth of money in the United States, much more rapid than in Canada.
At the peak, M2, the broadest measure of money, which is still published by the Fed, increased by almost 27%. You had nothing like that in Canada. In fact, since February of 2020, just before the onset of COVID, the U.S. money supply was up on a cumulative basis by 40%. Again, in Canada, you’ve had nothing like that.
That would say that inflation in Canada over the next two to three years will be significantly lower than in the U.S., and that deserves some premium for Canadian bonds, therefore, yields in Canada could well be lower than in the U.S.
Obviously, there are all kinds of short-term factors which influence bond markets, but in broad terms, if you create too much money, you will get a higher inflation rate, or the inflation rate will persist for longer. That’s what I expect for the United States.
Senator Gignac: Quickly and so well explained. Thank you for that. Bottom line, that suggests the Bank of Canada should stop increasing interest rates before the Fed or increase them much less because, if you compare the trend, the inflation trend is more encouraging in Canada than in the U.S. Even our other guests suggest the same thing. Do you agree?
Mr. Greenwood: Yes, I think that’s absolutely right, but you can’t tell that from the level of interest rates. The right way to judge it is as soon as the Bank of Canada gets the money growth rate back down to the appropriate growth rate, something around 6%, then it can stop squeezing and tightening. By maintaining money growth at that sort of level, you can be reasonably confident that, within a year or two, inflation would return to the 2% target.
That’s the way to do it but not to sort of get too stressed about the particular level of interest rates because, as I said earlier, there is no clear relationship between any particular level of interest rates and either the inflation rate or the growth rate of the economy. Interest rates are a symptom, not a cause.
Senator Gignac: Thank you for the clarification.
The Chair: Thank you for that. I can’t resist asking here, before we wrap up for the day, just because I know you have an expertise in terms of what goes on at the Bank of England and all the crazy political changes that have gone on there. What’s your assessment of the state of play in the U.K.?
Mr. Greenwood: Well, fiscal policy is being brought back on track in a very conventional sort of way, which is fine. Monetary policy, I think, is where the problems are. Like the Fed, the Bank of England has embarked on a policy of QT which is quite aggressive. In the current 12-month period, they plan to reduce the size of the balance sheet by £80 billion.
Now, if the banks don’t lend money to counteract that — that is, if bank lending growth is less than £80 billion — then we could also see money growth in the U.K. slump in the way that it has done in the U.S., and that would be highly undesirable.
A quick assessment is that fiscal policy is broadly back on track, although it will take several years to get to the objectives that the government has set out, but there are still a lot of questions in my mind about the conduct of monetary policy.
The Chair: Thank you for indulging me on that particular point. Thank you, Mr. Greenwood. It is possible we will be back to you again because one of the things we will be looking at in the future is the mandate of the Bank of Canada and how these things are assessed, and you would be most helpful on that. But today thank you so much for your insights and comments. Very interesting.
Mr. Greenwood: Thank you very much.
The Chair: To Mr. Ambler, if you can still hear us, we apologize one more time for our inability to solve the technical problems in order to have your words translated. We will reach out to you separately and outside this process and perhaps arrange for another time for you to return, but our thanks to you for today.
Mr. Ambler: No problem. I am happy to come back any time.
The Chair: That’s great. There you are. You can hear us. Thank you very much.
With that, the committee is brought to a close. We will see you next week, on Thursday. Thank you.
(The committee adjourned.)