THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Thursday, November 21, 2024
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 11:39 a.m. [ET] to examine and report on Canada’s monetary policy framework.
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Senators, apologies all around. We’re having technical difficulties this morning. We have connected with our first witness, but we have lost crucial time, so I will ask you now to think about your questions and keep them as concise and targeted as possible.
This is the weekly meeting of the Standing Senate Committee on Banking, Commerce and the Economy. My name is Pamela Wallin, and I serve as the chair of this committee. Members joining us today are Senator Loffreda, the deputy chair; Senator Ringuette; Senator Varone; Senator White — we welcome you as a new member to our committee — Senator Yussuff; Senator Gignac; and Senator Massicotte.
On October 10, the committee was authorized to study the Bank of Canada’s mandate, look at the framework, the inflation targeting, all of the issues, and so today we have the pleasure of welcoming Dr. Pierre Fortin, Emeritus Professor of Economics at the University of Quebec at Montreal, who worked closely with our former colleague Senator Diane Bellemare on these issues. Dr. Fortin, welcome. I understand you have some opening remarks, so please go ahead. The floor is yours.
[Translation]
Pierre Fortin, Emeritus Professor of Economics, University of Quebec at Montreal, as an individual: The main subject of my five-minute presentation is the legislative mandate that should now be given to the central bank. I think it is time to update our old Bank of Canada Act to clarify the role the institution should play.
[English]
The Bank of Canada Act should commit our central bank to pursue both a low, stable inflation rate and the highest sustainable employment rate, just as the U.S. Federal Reserve Act has been prescribing since 1977.
The government and the Bank of Canada have always jointly stated that “. . . the primary objective of monetary policy is to maintain low, stable inflation over time.” But their 2021 agreement took a step beyond this seemingly narrow vision by directing the bank to also promote maximum employment. It stated that “. . . monetary policy should continue to support maximum sustainable employment . . . .” The bank agreed to use the flexibility of its 1 to 3% control range to explore what this ideal level of employment — which is a priori uncertain — could really be without having to give up its comparative advantage in pursuing price stability. For example, it can modulate the speed with which it will be returning to the 2% inflation target when it is trying to steer the economy back to it with minimum damage to employment.
[Translation]
The 2021 agreement is a decisive step towards the dual mandate that exists in the United States. The question now is whether we need to go a step further and include the dual mandate in the Bank of Canada Act itself.
[English]
There are three compelling reasons to answer this question affirmatively: transparency, protection and trust.
First, there is need for transparency. It should be made crystal clear to all Canadians that monetary policy, alongside fiscal policy, must pursue the twin fundamental objectives of minimizing inflation and unemployment. Given the wide societal consensus on this, it must be encoded as a basic Canadian rule of law.
Second, there is need for protection. Engraving the dual mandate in the Bank of Canada Act would better protect the country against any possible attempt at rejecting either one of the two goals — minimizing inflation or minimizing unemployment — by ill-advised political authorities. Protection.
And, third, there is need for trust. Explicit reference to the dual mandate in the act would have the potential of increasing the trust of Canadians in their central bankers. They would less likely view them as narrow minds blinded by an obsessive fixation on the exclusive objective of minimal inflation as they now sometimes appear to the lay public. The modernized act would position them as custodians of the general well-being of all Canadians, whether they are households, workers, businesses or financiers. It would help eliminate for good distrust of the Bank of Canada independence and replace it with trust and esteem.
Thank you very much.
The Chair: Excellent. Thank you very much for those remarks, Dr. Fortin. We will go right into our questioning now, and we’ll begin with Senator Loffreda, our deputy chair.
Mr. Fortin: May I ask all of them to speak slowly and articulately because I have a hearing problem.
The Chair: Okay. And I’m asking them to speak more shortly as well, so we’re going to have very concise questions today. Thank you.
Mr. Fortin: I will try to be short.
Senator Loffreda: Welcome, Dr. Fortin. We are a nation of trade, and we are looking at the mandate of the Bank of Canada. We have discussed many issues, but on exchange rates, should the Bank of Canada place greater emphasis on managing exchange rate fluctuations given their impact on trade and on the broader economy? Canada’s gross domestic product, or GDP, is over 80% on trade, imports and exports.
Mr. Fortin: My short answer is no, not in general — the general operational organization of monetary policy. The Bank of Canada objective — the main objective on which it has a comparative advantage is to stabilize inflation, and that means it has to manage interest rates, and sometimes changing interest rates will have an impact on the exchange rate. So if stabilizing the exchange rate becomes the objective, the Bank of Canada will no longer be capable of using interest rates in order to stabilize inflation. In other words, if inflation stabilization is to be the objective, you should not try to stabilize the exchange rate.
Senator Loffreda: A short follow-up. Thank you for that. You are not concerned with the weakness of the Canadian dollar? We have a strong American economy, and our interest rates now, despite the last inflation number, which hopefully is temporary for many reasons — you are not concerned about the weak Canadian dollar, that wouldn’t be a concern to you and the impact it would have on the economy? You would remain and have the mandate stay the way it is?
Mr. Fortin: Good questions. Some people may be concerned by the low value of the Canadian dollar, especially those who are importers. Like all of us when we consume, there is import content on what we buy, and therefore there is an impact on the consumer price index, or CPI, inflation rate. On the other hand, there are people who are very happy to see the Canadian dollar at a low level, for example, our manufacturing firms who are desperately trying to be competitive in the North American markets. In other words, when the Canadian dollar is lower, our manufacturing firms are more competitive in the United States. So the Bank of Canada has to make a choice of whether it wants to stabilize inflation or to stabilize the exchange rate. If you want to stabilize inflation, you have to accept whatever the market decides the value of the dollar will be.
[Translation]
Senator Gignac: Greetings to our witness, Mr. Pierre Fortin, a brilliant emeritus economist, who is known not only in Quebec, but right across the country. He was my professor when I began university.
Mr. Fortin, I will address you formally for this occasion. I have two questions. The first relates to your article that appeared in the Globe and Mail on September 3, 2024, in which you suggested that there should be an independent review of its monetary policy. Can you elaborate on the rationale for such an exercise? I believe other central banks already do that. I will have another question after that.
Mr. Fortin: My answer will be brief. Yes, I agree with that objective and it could be introduced in an updated Bank of Canada Act, namely, the requirement for an independent external review of the Bank of Canada’s operations. At present, the bank reviews its own activities, but that is an internal review. I think that is something for you to judge, as senators, whether or not there should be an independent external review of the Bank of Canada’s operations.
I am definitely open to that possibility, but it is for you to decide whether that should be included in the Bank of Canada Act.
Mr. Galbraith made a very important point when he appeared before your committee: He said it is essential, regardless of an external review, for the act to stipulate that the Bank of Canada must report periodically and regularly to the House of Commons and the Senate on its operations. So the requirement to report regularly to the Senate and the House of Commons could be introduced into the act.
Senator Gignac: Here is my second question, quickly. In your opening remarks, you talked about one of the three focal points of our study: the mandate. You spoke very well about that. You must certainly also have an opinion on the second part of our study, the 2% target. Do you recommend that the Bank of Canada maintain its 2% target, which is the same as the Federal Reserve? Or should it reassess that target, as the IMF’s chief economist, Olivier Blanchard, did?
Mr. Fortin: In 1990, I wrote a report for the C.D. Howe Institute stating that the target should be based on the consumer price index. I did not specify what that target should be, but I did say that the bank must be allowed some flexibility. It accepted that recommendation and the flexibility of a target range between 1% and 3%.
I agree that the Bank of Canada should retain that flexibility for the target. That should not be part of the Bank of Canada Act, nor should the target itself. If at some point they decide that the target should be 1%, or between 3% and 4%, that should be agreed upon by the government and the bank and not be included in the act.
[English]
Senator Varone: Thank you, professor, for being here. The question I have — we all believe in that utopian goal of zero inflation and full employment, but do you find any correlation between full employment and worker productivity? My experience in business has been, and albeit in the sector of the construction industry, whenever we achieved full employment, productivity fell off and fell off drastically because we had no alternatives and no choices. Do you find that third rail of productivity something worth measuring when you talk about full employment?
Mr. Fortin: Sure. Productivity is how much Canada produces in goods and services in terms of real physical quantities per hour of work. But the correlation between the level of employment and productivity is very uncertain. I have read the whole literature on the direct connection between full employment and productivity, and, of course, we want both of them. We want maximum productivity and maximum employment, but it is not the case that lower unemployment means more productivity or less productivity. The causes of productivity are independent of the level of employment, as I read the literature so far. But, of course, it should be —
The Chair: Thank you very much.
[Translation]
Senator Ringuette: Hello, Mr. Fortin. We are pleased you could join us today. We are of course aware that you studied with our former colleague, the Honourable Senator Bellemare.
For my part, I have to say that I am in favour of a dual mandate and would like it to be included in the act to shield it from future political events.
You also indicated, as did the Honourable Senator Bellemare, that you would like the mandate to include consultation with experts from outside the Bank of Canada. Can you elaborate on that? What would that look like?
Mr. Fortin: I don’t think I can say much more about that. The Bank of Canada is a paragovernmental organization, as are the Caisse de dépôt et placement du Québec and the federal Public Sector Pension Investment Board. Those organizations are relatively independent.
Typically, the government sets the overall objectives of those organizations. Ultimately, the House of Commons and Parliament are responsible for organizations such as the Bank of Canada. Nonetheless, for the government to fully understand the effectiveness of its operations, it should be able to call upon not only outside experts, but also stakeholders and people who are affected by that organization.
Ultimately, Parliament and the government will make a decision on that. I would say reviewing its performance is a requirement, considering that the organization is somewhat independent from the daily operations of government. That cannot be done by the organization itself, of course, since there would be a conflict of interest, nor by the government alone since the government has a stake in the matter. That is why an independent external review is needed.
Senator Ringuette: Thank you. Perhaps my question was not clear because I was not referring to the independent external review. I was referring primarily to your statement with the Honourable Senator Bellemare, when you said, and I quote:
[English]
“. . . the central bank should rely more on outside expertise in its decision making.”
[Translation]
Should that requirement to consult be included in the act?
Mr. Fortin: Yes, my apologies; I was off track before. You talked about something else at the Bank of Canada: having a monetary policy committee that relies upon outside experts and not only people who have grown up at the Bank of Canada or are officially part of it. That has existed for a number of years, including at the Bank of England. A friend of mine who is a former professor, Willem H. Buiter, was a member of the monetary policy committee at the Bank of England. It’s normal.
I am not sure that requirement should be included in the Bank of Canada Act. I will leave that up to you, in light of the conversations you might have with officials from the Bank of Canada itself or perhaps even with officials from the Bank of England, who could tell you about the effectiveness of that institution.
[English]
The Chair: Thank you very much. We are intending to do just that.
[Translation]
Senator Massicotte: Welcome, professor. It is an honour to have you with us today. To clarify the dual mandate issue, listening to your arguments about inflation and the definition, I gather that you like things to be clear, which means that a dual mandate is not acceptable in your opinion because it complicates matters. There is a choice. It brings to mind the old debate about the Caisse de dépôt. To be clear, a choice has to be made and if we give the Bank of Canada a dual mandate, there will be confusion. People will wonder what the priority is or what is most credible. Can you comment on that?
Mr. Fortin: Yes. To begin, that does appear to have been a problem for the U.S. Federal Reserve, which has had that dual mandate since 1977. Having a dual mandate would not prevent the Bank of Canada from setting a priority, because it has an advantage in controlling inflation. On the contrary, it could retain its independence in pursuing that objective.
In addition to enhancing the reputation of the Bank of Canada — they are not narrow-minded people obsessively pursuing an objective — it would confirm what the Bank of Canada has in fact already started doing by setting a target of 2% inflation. That is the objective, but it has some flexibility, from 1% to 3%, considering that everything it does also has an impact on employment.
It could accelerate or delay achieving the 2% target because the act and even the agreement with the government do not stipulate that the Bank of Canada has to reach 2% within three months, six months, a year or a year and a half. On the other hand, a dual mandate or joint mandate, which is how the U.S. Federal Reserve operates, dictates that caution must be exercised since keeping interest rates higher for a longer time can negatively impact employment. Then it might lower interest rates more quickly in order to protect employment.
I agree with you. It is complicated. But what can you do, as the greatest political philosopher of the 20th century, Jean Chrétien, said, what can you do? Life is complicated and having dual objectives is in line with the way Canadians think. We need to have the lowest possible rate of inflation and the lowest possible unemployment rate. That is our political reality, very simply.
Senator Massicotte: Thank you very much.
[English]
The Chair: Thank you very much for those answers and the philosophical ones as well.
Senator Yussuff: Professor, thank you very much for taking the time to be with us this morning and to share some of your thoughts. Clearly, if we are going to get to a dual mandate, we need a framework to consult Canadians in this endeavour. In that context, I notice your reflection that that should be done and maybe through an external body.
Do you think Parliament is the right institution to engage in this conversation that could bring witnesses and Canadians together to learn how a dual mandate has benefited other countries, but equally how we can manifest a way in this direction that will be in the interests of the country and also in the interests of Canadians in general? Quite often, they are the ones who suffer at hands of the bank when the interest rates go up, and they have to deal with that reality. Now they can understand more so the importance of this and how this would give the bank a bit of a balancing act in trying to meet these objectives.
Mr. Fortin: Yes. That’s my answer. Our elected representatives in Parliament and our representatives in the Senate do have feedback from their constituencies on the kinds of situations they are suffering from or benefiting from. Those elected representatives have to report those feelings of their electorates within Parliament. Then there could be a serious and productive exchange between the executive branch of government, the Bank of Canada and all the elected representatives.
This is democracy at its best, and that’s why I fully support Jamie Galbraith’s suggestion that a major amendment that was brought up in the United States by the Humphrey-Hawkins Act was that the Federal Reserve would be obliged to make a presentation and to make exchanges with Congress every such and such period. I don’t know the exact period, but we could have exactly the same thing in the Bank of Canada Act to the great benefit of all of our fellow citizens.
Senator Yussuff: My last point deals with recognizing the confidence that Canadians have in the institution and maintaining that confidence if we were to change policy objectives to having a dual mandate. Given the U.S. experience in this regard, do you think there is a broad understanding as to how this has served the U.S. well and, more importantly, how this might benefit Canada given that we are still stuck in the past and the Americans have been going in a new direction for quite some time? It looks to me like the dual mandate has served their economy and also served the interests of their citizens in a very profound way, to recognize that the dual mandate reflects the modern reality of the economy to a large extent.
Mr. Fortin: Yes. First of all, the U.S. experience with the dual mandate gave them a better performance in terms of both unemployment and inflation than Canada until around 2000.
Since 2000, the Bank of Canada has more and more moved toward a dual mandate. It is not in the law, but it has moved; it has experienced more flexibility to take account of employment more than in the previous period.
In this new environment, since 2000, Canada has performed as well as the U.S. in terms of employment and inflation, which is an additional argument to make the dual mandate part of the bank because we have already experienced it and it gives good results, even if we were not forced by the Bank of Canada Act to have a dual mandate.
Then what about tariffs that could be imposed by the new government in the United States? I would say that this is an additional and forceful argument to allow the Canadian dollar exchange rate with the U.S. dollar to fluctuate according to the needs of the Canadian economy, to adjust to the imposition of, let’s say, a 10% tariff on whatever we export to the United States. Without that flexibility, if the exchange rate were to be fixed to the U.S. dollar, we would not have this kind of required flexibility for our economy to adjust to the tariff shocks.
Greece, Italy, Spain, Ireland and Portugal, for example, had to face this in 2010 and 2013 when they were hit by big macroeconomic shocks without the power to change their exchange rates because they were all tied to the euro. Exchange rate flexibility is crucial if we want to continue to focus on stable inflation at around 2% or perhaps 3% if we want to raise it to 3%. But that would be a decision the government and the bank would have to take themselves.
The Chair: Thank you. To follow up on this discussion here, you’ve used the phrase “performance review,” which is an interesting way to put it, and that that would be conducted in a sense by the parliamentarians, both in the House and in the Senate, and that process would be public.
I have two questions about that. Mr. Galbraith suggested that the transparency itself — the public nature of that questioning — makes the bank more answerable and responsive. But I’m wondering what you would suggest for consequences if somehow the bank, in the judgment of the parliamentarians or in their read on the public’s judgment, was not meeting those?
Mr. Fortin: That would require some analysis, not only by experts but by the knowledgeable people who are our elected representatives on the evolution of unemployment and inflation in the past few years. A very well-known indicator would be simply to add the two rates, those being the unemployment rate and the inflation rate. You add the two, and the sum of the two is called the misery index. It was invented by the American economist Arthur Okun who was an adviser to President Kennedy and President Johnson.
Then we could look at that index and say, “Well, yes, this is something that should be looked at.” Performance should be measured. Some people would like to put more weight to unemployment and others more weight to inflation.
The good thing with having the dual mandate in the act is not only to add minimizing unemployment as an objective but also to ensure that no political authorities in the future could determine that we will no longer minimize inflation. In other words, it is to protect inflation as well as the unemployment — not only for unemployment; the two of them have to be the objectives pursued by the Bank of Canada.
How was my English?
The Chair: It was excellent. Really, you are saying — and this reflects what Mr. Galbraith was saying, too — that this is a kind of sunlight? It’s exposure that keeps the pressure on the Bank of Canada to have its policies reflect the needs of the Canadian population, not just internally inside the bank or even through political masters?
Mr. Fortin: Absolutely. Putting this dual mandate into the Bank of Canada Act is not a partisan suggestion. You no doubt know that Jamie Galbraith is a leftist. Honourable Madam Bellemare is a centrist. Earlier, she was close to the NDP, but later she was the main economic adviser to the Conservative provincial party in Quebec, which was the ADQ, Action démocratique du Québec. She is at the centre. She has ways on the two sides.
My personal position is more conservative than the two of them. My grandfather was a senator in the 1930s, and an MP before that. It is always with emotion that I come before your audience here. This grandfather was a Conservative member. Of course, in the 1930s, the nominations were made by R.B. Bennett.
The Chair: That context is actually very important, so thank you for that. We will have two quick questions because our time is almost over.
Senator Loffreda: Thank you, professor, for being here once again. My question is on monetary fiscal coordination. In your opinion, how crucial is the coordination between fiscal and monetary policy in achieving economic stability? Is Canada currently striking the right balance? You talked in your opening remarks about transparency, trust and esteem, and you weren’t too strong on the independence side. I would like to hear your thoughts on that.
Mr. Fortin: You are always the one asking the most difficult questions, but I like that. Of course, the government and the Bank of Canada have to be in conversation every week. I don’t know if it’s still the custom, but the Governor of the Bank of Canada used to meet the Minister of Finance every Wednesday. I don’t know if it’s still the custom. What about at this time? I don’t know what kind of judgment I should bear on this.
It may be that the government because of the level of the deficit — which should be lowered at this time — should go in that direction because the higher the deficit, the higher the interest rates that will be imposed on government borrowing in international markets. More prudent fiscal management by the government would help lower interest rates in Canada, especially long-term interest rates.
At the same time, it would be possible for the central bank, the Bank of Canada, to lower interest rates faster than it has done so far.
The Chair: I’m not sure if he said it —
Mr. Fortin: So that’s it. I cannot go farther than that.
The Chair: Yes. No, no. I’m not sure whether the governor said it at lunch, but he did say it in speeches publicly that he would like that behaviour demonstrated on the part of the government.
Senator Gignac: I will try to have a much easier question than my colleague, who has the reputation of being a troublemaker. No.
Senator Massicotte: But he’s a nice guy.
Senator Gignac: He is a nice guy.
Mr. Fortin, since we have you here, we have three items in our special study. The third item is a pretty technical item, and it is the way they measure underlying inflation. The Bank of Canada, for 15 years, has one indicator — the CPIX — and they have changed, and now they have flipped around. But I notice that some other central banks, like Sweden’s central bank, they have one indicator for the underlying inflation, which is overall inflation without the interest rate impact. Why? Because the central bank decides about interest rates. It is normal to exclude that item. Just curious to know your view. Any thoughts regarding that, the opportunity to shift the indicator for measuring underlying inflation?
Mr. Fortin: I’m in full agreement with the Sveriges Riksbank, the central bank of Sweden, having decided to exclude mortgage interest costs from the inflation target they are going to aim to simply because this component of the CPI, mortgage interest costs, can be raised or decreased directly and very quickly by the central bank’s actions. The CPI, without mortgage interest costs, is the indicator that measures the true state of the economy independently of what the central bank does.
So I think it’s common sense — and the Swedes are known for being plain, commonsense people — to exclude this aspect of the CPI, while I think the bank is right to want to continue to use the CPI as the basis of its inflation target.
The Chair: Our thanks in general, Dr. Fortin, for being with us today. Your insights and your expertise on this topic are most helpful. Dr. Pierre Fortin, Emeritus Professor of Economics, University of Quebec at Montreal.
For our second panel today, we have the pleasure of welcoming John Greenwood, OBE, SBS, Chief Economist, International Monetary Monitor.
Mr. Greenwood, I understand that you have some opening remarks, and so the floor is yours.
John Greenwood, OBE, SBS, Chief Economist, International Monetary Monitor, as an individual: Thank you, Senator Wallin. Good afternoon, everybody. In recent decades, governments have given central banks an objective, usually an inflation objective, but they have given them full discretion on how they achieve that objective. In Canada, this has become known as the flexible inflation targeting framework, and it serves as an internal anchor to stabilize the price level. There are countries where the policy is different. I am familiar with Hong Kong and Singapore where they have an external anchor, that is, a fixed or managed exchange rate. But for a very small, open economy with very large capital movements, that is appropriate. As you heard in your last session, most economists would not think that’s appropriate for Canada. So a floating exchange rate regime is most appropriate for Canada.
In my view, there is no reason to question Canada’s adoption of inflation targeting. As I understand it, there’s been this supplementary goal attached through the monetary policy framework review in recent years to attain maximum sustainable employment. I don’t have an objection to that. I also see no reason to question the adoption of the specific inflation target, that is, 2% as measured by the consumer price index with an inflation control range of 1 to 3%. No problems with any of that structure.
However, in light of Canada’s actual inflation experience during and after the COVID episode, inflation targeting was, at the least, derailed or it clearly failed.
In my opening statement, which the clerks will circulate afterwards, I go into some detail on the reasons for that deviation of the inflation from the target range and, secondly, changes in the guidelines or operational requirements for the Bank of Canada to prevent such a recurrence occurring in the future. I will sketch those two things very briefly now.
The predominant reason for the inflation given by the consensus of economists is that it was due to a whole series of external shocks, resulting from the pandemic and then exacerbated by the start of the war in Ukraine. Now, there are numerous problems with this view, and my opinion is that that view is not correct. One problem with the view that it was external shocks is that asset prices, such as equity prices or house prices, started rising in the middle of 2020, well ahead of any big surge in consumer goods prices. So that suggests an alternative source of the price surge. Second, the individual markets that were subject to price rises — things like computer chips or second-hand autos or commodities — these are what we call relative prices. They do not justify or explain a rise in the overall price level.
If I have to spend more on gasoline at the petrol pump, then I’ve got less money to spend on other things. If we apply that to the whole economy, what will happen is that while the gasoline price may go up, other prices are forced to come down a smidgen. So that argument simply does not hold water.
The third problem with the story of the disrupted supply chains causing the overall inflation is that there were numerous countries, notably Japan, Switzerland, China, India and Indonesia where there was no significant rise in inflation whatsoever, yet these countries were exposed to exactly the same supply disruptions facing Canada, the U.S., the U.K., the Eurozone and so on. We have to come up with a different explanation.
My explanation is that the policies adopted by the Bank of Canada, the Reserve Bank of Australia, the Reserve Bank of New Zealand, the Fed, the Bank of England, the European Central Bank, or ECB, and so on, and the quantitative easing, or QE, policies in particular, created a large quantity of money which ultimately translated into a much higher rate of inflation. So the profile of inflation obviously followed the individual markets. If oil prices went up, then the overall inflation appeared to go up. What validated or enabled that was the prior rapid growth of money.
It is probably worth a moment of digression here to say that after the global financial crisis in 2008 and 2009, a number of countries did adopt QE. Their central banks did expand their balance sheets rapidly, but that did not cause inflation. Why was it then that QE created inflation at the time of COVID but not in the earlier period?
The answer is that, most of the time, the commercial banks create money by making loans. When they make a loan, they credit the deposit account of the borrower. At the time of that global financial crisis, commercial bank balance sheets were severely impaired by losses in the subprime housing market and securities losses related to the housing market. Banks basically withdrew from lending. In the United States, for example, bank lending declined by almost a trillion dollars. If that had been allowed to translate into the rate of change of money, that would have led to a sharp drop in the quantity of money similar to what happened in the Great Depression of the 1930s.
The Chair: Mr. Greenwood, I would like you to conclude that point because we’re all waiting for your assessment here, but we need to get to our questions shortly.
Mr. Greenwood: Sure. To move on from that, my second point is that in order to prevent such a surge of money growth in the future, it’s probably appropriate to adjust the mandate to deal with that excess discretion that central banks have. The way I would deal with it is to impose the monetary equivalent of a fiscal debt brake. You would have an upside limit of, let’s say, 10% on broad money growth and a downside limit of 2% on broad money growth. The effect of that would be that you would limit either excessive growth or inadequate money growth, but you would retain the inflation target. You would retain the maximum sustainable employment objective, but you would impose this additional monetary brake. The net results would be highly favourable for Canada over the longer term. Thank you.
The Chair: We’ll come back to those issues. That is very helpful, and we will distribute your remarks. We have done it online right now.
We’ll begin our questions with the deputy chair, Senator Loffreda.
Senator Loffreda: Thank you, Mr. Greenwood, for being here with us this morning. I’m impressed with your global analysis. My question is on global comparison. How does Canada’s approach to monetary policy compare to that of other advanced economies? If you can elaborate, what lessons can be drawn from these comparisons to improve effectiveness? You did mention Japan, Switzerland and Indonesia having no inflation. Without getting into it and repeating all your comments here, I found them very insightful. The question is how can we learn?
Mr. Greenwood: Most central banks adopt very similar inflation-targeting formulae for their day-to-day operations, but, in practice, these central banks did not respond to COVID by rapidly increasing the size of their balance sheets. In some cases, it was because they did not see a need to do that. I would say that’s the case in China. That was the case in Indonesia. In Japan, they did a small amount through bank lending rather than through quantitative easing. In Switzerland, I’m not sure what the reasons were.
The reasons were different, but the bottom line is that the effect of standing back or not doing the quantitative easing was that their money growth rates did not accelerate as we saw in the U.S., in Canada, in the Eurozone, in the U.K., in Australia and so on.
Senator Loffreda: Thank you for that. You also quickly discussed money supply, and you’re a proponent of it with the upside limit and what have you. What can we learn from historical lessons? If we look at the monetary policy strategy in Canada — the money supply is a monetary strategy — it was not deemed a major success for many reasons. You know the reasons as well as I do, if we look at our historical lessons. Any thoughts on that? Are you really strong on creating that upside limit and money supply?
Mr. Greenwood: I don’t believe that central banks have the tools to manage the money supply month to month, let alone on a week-to-week basis, so I’m far from proposing a short-term objective of keeping money on a narrow growth path. I don’t believe that’s feasible or desirable. But if you look at the evidence around the world, you cannot find an example of a sustained high rate of inflation that has not been preceded by a rapid rate of money growth.
It’s my view that what has happened in the last two or three decades is that central bankers have dismissed money as a macroeconomic indicator. As a result, as I suggested in my opening remarks, when there was a need for additional liquidity at the beginning of the COVID crisis, the central banks ignored the quantity of money they were creating. They went, in a very big way, to increase the quantity of money through quantitative easing operations. The result was this surge in money growth across the world, with the exception of the countries that I named.
The evidence is that if you let it create too much money, you get inflation. I’m not saying that you’re going to get a shorter‑term control over inflation because there are lots of things that affect inflation in the short run. What we do know from a number of examples is that if you have a moderate and steady growth of money, then you will not have a problem on the inflation front.
Senator Loffreda: Thank you. The old saying is that money is like oxygen. If you get too much, you get too high. If you get not enough, you’re gonna die.
Mr. Greenwood: I would agree with that.
Senator Ringuette: Just an explanation in regards to Japan and their low inflation after COVID. My understanding is the way that the Japanese government handled potential high inflation is mostly because there is a central body that buys the petroleum product necessary for the citizens of the country, and it then resells to its citizens at a reasonable, low-inflation price. So that’s my understanding, unless you have other information that you would like to share with us in regards to Japan.
Mr. Greenwood: I lived in Japan for four years, and I studied economics there. No, Japan does not have a general regime of government price fixing. It is an open, free-market economy, very much like Canada, and the price of energy, along with the prices of many other commodities, is free to vary in private markets. So they don’t fix their prices.
Inflation in Japan has been low because money growth in Japan has been very low. In my view, it has actually been too low, but that’s really a separate issue. But by keeping low money growth, they have had a sustained low rate of inflation, and that’s really the story of the last 25 or 30 years in Japan.
Senator Gignac: Thank you to our witnesses. We are very fortunate to have you.
Since we have you as a witness, I want to ask you about a different aspect. Do you find that government and central banks use enough macroprudential tools? Because when you have a supply shock, maybe it is better to use macroprudential measures rather than just monetary policy to fight inflation. Could you elaborate a bit more on that, if possible? Thanks.
Mr. Greenwood: Yes, I think I’m right in saying that macroprudential tools are primarily used for restraining the growth of debt and preventing balance sheets from becoming overstretched. I also lived in Hong Kong for many years, and Hong Kong pioneered the use of debt-to-income limits on mortgages so that — and also limits on the loan-to-value ratios for mortgages. So these are very desirable to prevent individual sectors from becoming leveraged. Most or many financial crises start from leverage. If you prevent the buildup of leverage, then you don’t get the crisis.
In the global financial crisis, it was the financial sector and the household sector which became leveraged. If macroprudential tools had been used more widely, then those debt levels would not have become so high. Macroprudential tools are useful from that point of view, that is, limiting leverage, but debt and money are different things, and macroprudential tools don’t prevent excess money growth.
Senator Gignac: In plain English, if I understand, it is more of a tool to prevent inflation on the asset prices rather than really a useful tool to monitor the goods and services inflation or prevent inflation on goods and services. It is more a risk to the asset price than the goods and services. Do I understand that correctly?
Mr. Greenwood: Yes, I agree with that interpretation. So the macroprudential tools are applied to the balance sheets of banks for loans, and a large part of banks’ lending is for the purchase of assets. So you are right.
The Chair: I want to come back to the point you were making in your opening remarks and how you stated it in your formal presentation here as well that what spurred the inflation was not the result of all these supposed external shocks, but, really, the Bank of Canada’s massive purchases of government securities or printing money to fund what the government was doing at that time, and it kept ringing up. So in our look at the mandate of the Bank of Canada and the constraints, restraints and transparency that is needed there, what mechanisms could you suggest for a future situation like this for the Bank of Canada to be able to say to governments, “You have got to slow the rate of spending and therefore the pressure on us because this is going to be inflationary,” for example? How do they push back without getting into that very direct political exchange?
Mr. Greenwood: Well, there are a number, not a lot, but a number of cases where government debt has grown rapidly, but the central bank has not purchased that debt, and a case in point is Japan. Japan has run huge government budget deficits in recent years, and the government debt-to-GDP ratio is very high. It is over 260%. But all of that debt has been funded in the markets, that is, just by financial institutions, savers, sovereign wealth funds and so on. So the important thing is that the Bank of Canada has the discretion or the independence to avoid directly financing government expenditure. As long as it doesn’t buy those securities and its balance sheet doesn’t grow very rapidly, then those securities issued by the government will have to be bought by non-banks or by savings institutions, and as long as that happens, then the debt on its own is not going to be inflationary. It is money that creates inflation, not debt.
The Chair: But in this circumstance — and we remember it all too vividly — it was, “We don’t know how long this crisis will last. We need to do this. We need to get cheques out the door to Canadians. We need to fund or subsidize this program and that program.” When you are in a crisis mode, it is hard to find the checks and balances.
Mr. Greenwood: It is, indeed, and I have an answer to that problem, and that is also in my paper that has been circulated. That is that if the central bank, if the Bank of Canada in this case, had concentrated on injecting liquidity by means of purchasing or doing repos with short-term instruments, instruments with a maturity of one, three, six months, then the money would have been injected, but then all those securities would have matured and rolled off the Bank of Canada’s balance sheet. Instead of that, the Bank of Canada purchased, very largely, Government of Canada long-term securities so that, first of all, the securities remained on the Bank of Canada’s balance sheet and, secondly, the money created as a result of that remained in the hands of the public, and that’s what produced the inflation.
The Chair: So they had the tools, they just didn’t use them?
Mr. Greenwood: I believe so. I think that they could have done this on the model of the Bank of England on numerous occasions in the 19th century when there was a panic in the money markets, as we had in March of 2020, and the Bank of England injected money but then withdrew it within a few months. Because the time lag between creating money and the inflation is something like a year and a half to two years, if you withdraw the money within a fairly short time frame, then it is not going to create inflation.
The Chair: Very interesting. Thank you.
Senator Yussuff: Thank you, chair. Mr. Greenwood, during the 2008 crisis, one of the things that all central bankers were trying to deal with was, of course, how to keep the economy going, and quantitative easing was the central plank in their efforts to ensure the economy didn’t collapse. It didn’t generate the level of inflation we saw from the COVID crisis. So quantitative easing, at times, has been used very successfully to manage, of course, the challenge that central bankers were trying to help manage with governments. It would appear to me, unless I’m completely wrong, we had a different effect back in 2008 compared to what we had in the most recent crisis with COVID.
Mr. Greenwood: I tried to explain that very briefly in my opening remarks. Forgive me if I’m repeating myself, but there was a need for liquidity in both cases. In the global financial crisis case, the banks themselves were impaired, so they withdrew from lending. It fell to the central banks, if you like, to create the money to enable the economy to continue to spend and grow. But in the COVID crisis, the banks were in good shape and, in a number of countries, lent into the downturn. Certainly in the U.S. they did that. But because the banks were in good shape and were ready to lend and create money at the normal pace, the additional money coming from the central bank fuelled an excess growth of money, and that created the inflation. That’s the difference between the global financial crisis and the COVID case, as I see it.
The Chair: I just want to come back. I know you have spelled this out in your document, but I would just like to hear you on a follow-up to my own question. You have described that the bank would need to employ a monetary brake and that there would be a place at which that would kick in. How detailed could that be so that it would be known to governments, the public and other financial institutions alike as to when the bank should and could put on the monetary brake?
Mr. Greenwood: I think it would have to be spelled out along with the inflation target, and it would have to be expressed in terms of the broadest quantity of money. It does not make sense to use the Bank of Canada’s balance sheet, which is not used as money by the vast majority of people in the economy; and it does not make any sense to use something like a narrow definition of money because people can move money from non‑interest-bearing demand deposits to interest-bearing deposits. So you need the broadest measure of money, which also actually gives the best relationship with the GDP measured in current dollars.
Just as the public will know that the inflation target is 2%, they will also start to learn that money growth is subject to these broad limits of — well, I have proposed 2% and 10% but others may have a different view.
The Chair: Okay. That’s very helpful. You would want to see that as part of the mandate and spelled out as clearly as an inflation target or an employment target.
Mr. Greenwood: Yes, because the central bank officials must be accountable for that, and if they exceed it, then they have to answer for that.
The Chair: All right. Thank you. This has been very instructive. We really appreciate this. It is a difficult topic to get our heads around, but we are trying to be very explicit in our advice and thoughts on that, and you have really given us a lot of meat on the bone here. Thank you so much for being with us today, Mr. Greenwood. I know you have been a witness with us before, and we always appreciate it. The Chief Economist with the International Monetary Monitor, thank you for your time.
Mr. Greenwood: Thank you.
The Chair: Senators, that concludes our meeting today.
(The committee adjourned.)