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The Progressive Economics Forum

Broadening the Bank of Canada’s Mandate

Yesterday, Mike Moffatt took to The Globe and Mail’s “Economy Lab” in response to my suggestion that the Bank of Canada should moderate the exchange rate. (Perhaps his motive for encouraging me to seek the Saskatchewan NDP leadership was to get me as far as possible from the levers of monetary policy.) 🙂

My rebuttal of Mike’s rebuttal appears in today’s Economy Lab:

Mike Moffatt’s friendly rebuttal of my comments on last week’s inflation report advances an important debate about Canadian monetary policy and the exchange rate. In fact, I believe that we agree on several key aspects of the central bank’s capacity to moderate our overvalued loonie.

The OECD calculates that a Canadian dollar has only as much purchasing power in Canada as 80 American cents in the United States. But our dollar has been trading for more than 100 American cents on financial markets.

Canadian-based exporters buy their inputs using the currency’s actual purchasing power, but then must price their output at the much higher exchange rate. This squeeze on exports has helped push Canada into a trade deficit, which subtracts from economic growth and employment.

In July’s Monetary Policy Report, the Bank of Canada states, “Canadian exports are projected to remain below their pre-recession peak until the beginning of 2014, reflecting the dynamics of foreign demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar.”

How can our central bank address this problem? Professor Moffatt and I agree that there is some room to cut the overnight interest rate below 1 per cent, but that doing so might not significantly alter the exchange rate.

Prof. Moffatt writes, “Perhaps he wants something more unconventional, such as the Bank directly intervening in foreign exchange markets by selling Canadian dollars.” That is indeed what I have been unsuccessfully advocating for three years.

And this proposal is not particularly “unconventional.” During the past two years, the Japanese, Swiss and Brazilian central banks have intervened in foreign exchange markets to moderate their overvalued national currencies.

Prof. Moffatt objects that such action “would violate the Bank’s current mandate, as set by the federal government.” This argument discards the mythology that the central bank is completely independent and implicitly acknowledges that the federal government could amend its mandate.

The preamble to the Bank of Canada Act envisions a mandate “to control and protect the external value of the national monetary unit and to mitigate by its influence fluctuations in the general level of production, trade, prices and employment.” But since 1991, federal finance ministers have instead ratified a narrow focus on inflation targeting to the exclusion of all other objectives.

As Prof. Moffatt argues, the rationale for lower interest rates in Canada is to reduce unemployment. Many central banks, including the U.S. Federal Reserve, have explicit mandates to maximize employment.

During the global financial crisis, the Bank of Canada took action to stabilize our financial system. As chair of the Financial Stability Board, Governor Mark Carney is engaged in international financial regulation and oversight.

Rather than continuing to pretend that the central bank can or should only manage inflation, the federal government should broaden its mandate to include employment, the exchange rate and financial stability. A broader mandate for the Bank of Canada would be entirely consistent with Parliament’s intention when it first established this important public institution.

Enjoy and share:

Comments

Comment from Paul Tulloch
Time: August 21, 2012, 1:05 pm

Here is the bottomine- as you note PPP is at around 83 cents compared to the USA.

So why is the Cdn dollar, valued at 20 cents above our largest trading partner? And why is our manufacturing and other export businesses put at such a disadvantage on a per dollar basis with similar producers and service providers in the USA and elsewhere (that is excluding a whole pile of poor trade policy that you can pile on top of that overvalued dollar)

Why?

Harper’s open door policy on the tar sands and his single minded pursuit to develop this asset as fast as possible to essentially sell away the tar sands to the highest bidder (typically foreign) Where else can a global interest got to purchase oil producing land?? Nowhere but Canada, and that has created a massive spike in demand for Canadian dollars and also set off a furry of trading activity in the Forex markets that have usurped control over our dollar.The race to develop the tar sands, which has been the single biggest force that has pushed the dollar to such lofty heights.

I have a graph right here that shows that since Harper has been in power over the past several years that the correlation between the Canadian dollar and West Texas Oil has basically doubled, from a mere 0.4 to a very lofty 0.8, and it has been a historical doubling- never before has one commodity dominated the valuation of our dollar.

There are ways as Erin indicates that the Bank could have helped mitigate the over valuing of our dollar, however when you have your finance minister come out and publicly state a high dollar is good for the country then I am sure that is all the signalling that Carney needs to sit on his hands.

Mike can label you all he wants to that your ideas are unconventional, however, I would have to conclude that he must have his head stuck up some tories ass.

All through history, beggar they neighbour dollar policies have been the tool to deal with exchange rate disadvantages. And many that you mention are more common in economic history than the cold.

Comment from Brian Dell
Time: August 21, 2012, 11:14 pm

But you can’t have it both ways.

Another post on this site calls for more investments in productivity, which suggests a HIGHER loonie is desired since that would allow businesses to import more equipment for no increase in real cost. A cheap loonie makes hewing wood, drawing water, etc relatively more attractive because a lower currency increases international demand for Canada’s raw materials as well as Canada’s finished products and raw materials can typically be put on the market with less investment than finished products.

Comment from Brian Dell
Time: August 21, 2012, 11:32 pm

“a Canadian dollar has only as much purchasing power in Canada as 80 American cents in the United States.”

I do not believe the OECD data supports this claim. The more valuable a currency, the HIGHER its purchasing power. The problem (if there is one) is the weak purchasing power of the US dollar, not the Canadian dollar.

The OECD gives an example of the sort of claim that its data supports:
“…If you have 120 for Finland, it means that the price level in Finland is 20% higher than in Canada. It means that you would spend 120 dollars in Finland to buy the same basket of goods and services when you spend 100 in Canada.”

So with respect to the USA, you would spend 79 CAD in the US to buy the same basket that would cost 100 CAD in Canada. This is what the OECD is saying. What was claimed in this post is not equivalent, since this post makes a claim about the Canadian dollar’s purchasing power “in Canada” not the Canadian dollar’s purchasing power south of the border. The OECD sets the Canadian dollar’s purchasing power in Canada and the US dollar’s purchasing power in the US both to 100 as a matter of convention.

Comment from Purple Library Guy
Time: August 22, 2012, 1:26 am

Mr. Dell, basic logic suggests that no export-oriented business would spend more on capital equipment purchases than they expected to make from selling the goods produced with that equipment. Obviously the effect of a high dollar will affect them via their sales more than via their equipment purchases. And of course that assumes that no such equipment can be made in Canada, a sad assumption. It may well currently be mostly true, but is precisely the kind of thing that a policy of “investments in productivity” should address.
In any case, arguments about what a cheap loonie logically should or should not do ought perhaps to bow to factual experience; it so happens that the loonie used to be lower, and the share of our economy based on manufacturing used to be higher.

Your second post seems to be living in bizarro world, or at best seriously miss the point. You wouldn’t spend $79 CAD in the US to buy anything, you would have to trade at par for $79 US and spend those, and those $79 US would buy you what $100 CAD (or $100 US traded for $100 CAD) would buy in Canada. Obviously the issue is not the weak purchasing power of the US dollar. The issue of purchasing power is, what can you use a unit of Currency A to buy in a place where it is legal tender? What can you use a unit of Currency B to buy likewise? And how do they trade against each other? If I can take my unit of Currency A (e.g. $Cdn), trade it for Currency B (e.g. $US), spend the result where Currency B is legal tender and purchase more stuff than I would have gotten if I’d used Currency A in country A, then the purchasing power of Currency B is higher, the purchasing power of Currency A lower.

Comment from Silas Gordon
Time: August 22, 2012, 11:58 am

I’m never a fan of non elected government organizations having so much control over the economy, but to be honest it seems like the Bank of Canada is doing a fantastic job these days. I wonder how low the dollar will go once the economy in the states recovers. The hockey fan in me hopes for no lower than 0.90 US for a Canadian dollar.

Comment from Keith Newman
Time: August 22, 2012, 10:11 pm

The Bank of Canada can of course sell any quantity of Canadian dollars it wishes to buy US dollars and engineer a drop in our currency. This is part of an export led economic policy that a number of countries have used, the best know being Japan and Germany. (Usually the other part of that policy is to keep a lid on wages, but I digress). However we do not have a highly developed economy like theirs. Our economy is very resource dependent. The exporters helped by the drop in the Canadian currency would be primarily resource producers – oil, natural gas, rocks and minerals, forest products, electricity. Certainly various other manufacturers would be assisted as well and the lower the value of our dollar the more would be assisted, all the way down the value added chain.

However there are costs to a lower dollar. Non-exporters and their workers, the majority of Canadians, would pay for this policy through higher costs for many imports and foreign travel (another kind of import).

I believe this is not the best way to deal with the economic problems we face. The high value of our currency stems from high resource exports. As soon as resource prices drop so does our dollar. Rather than subsidize our resource exports with an engineered low dollar we should rein in these excessive exports. For instance we could reduce our oil and electricity exports. It makes no sense at all to pollute our country for the benefit of foreign automoble drivers or to provide cheap clean electricty to competitors in the US economy. Of course expecting a change in our resource-based orientation would require an end to the colonial mindset of our economic elite – a huge challenge. How do you change attitudes that are centuries old? Worth a try certainly but let’s not get our hopes up.

Simpler would be to couple the ability of the Bank of Canada to create any quantity of Canadian dollars, an ability required to engineer a significant drop in the value of our currency, with the fiscal capacities of our federal government to increase national spending on public services (education, senior home care, daycare, pharmacare, etc), on infrastructure, public transportation, job creation for youth and the long term unemployed, and on and on. Part of the increased income in the hands of Canadians would inevitably be spent on foreign imports and put downward pressure on our dollar. And in the bargain we would have received more public services, etc.

Those concerned about the increased federal deficits that would result would need to explain why exactly an accumulation of liabilities in Canadian dollars by the federal government is a problem for a government that has the ability to create as many of those dollars as it wishes. They would be hard pressed to do so as there is none. There is of course an inflation limit – the government could spend beyond the ability of the economy to produce some goods and services and trigger unwanted inflation – but that is another issue requiring intelligent planning in the spending program.

Non issues include solvency of the federal government and future affordability of programs, future interest payments being too high, taxes needing to rise in the future due to higher federal government debt levels, and financial burdens on our children and grandchildren.

Comment from Purple Library Guy
Time: August 23, 2012, 11:25 am

You make some interesting points. One niggle, though–in the medium term, I’m not sure more expensive imports would be a bad thing. Might lead to a bit of import substitution–making things ourselves for the domestic market rather than importing everything. It might not be a sufficient pressure on its own to prompt that, but it would help.

But I do tend to agree that if we have an overly strong dollar, printing some money and using it to do useful things strikes me as a move with little downside. That is, what normally would be the downside danger is in this case the actual policy goal, so why not? There may be reasons but so far nobody has explained them to me.

Comment from Nick Falvo
Time: August 24, 2012, 2:34 pm

Great post, Erin!

Comment from Brandon L
Time: August 27, 2012, 5:01 pm

” If I can take my unit of Currency A (e.g. $Cdn), trade it for Currency B (e.g. $US), spend the result where Currency B is legal tender and purchase more stuff than I would have gotten if I’d used Currency A in country A, then the purchasing power of Currency B is higher, the purchasing power of Currency A lower” False statement, to make the argument the US dollar is a stronger currency then the Canadian currency. If Ben Bernanke tomorrow raised the cost of borrowing US dollars, reduced the balance sheet of the FED. Its American currency, currencies from Canada to Australlia have shot up, even the Yen is worth more traded against US dollars then in past decades we are bidding against Americans, and Americans cannot purchase the same amount of goods & services they use too when we had weaker currencies.

Comment from Keith Newman
Time: August 28, 2012, 10:09 am

Re Purple LG @ 11:25am
Indeed, the UPSIDE to a lower currency is more jobs at home through more exports and some import substitution due to less competitively priced imports. My point is there is a DOWNSIDE to this carried by the non-exporting sector.

An alternative is to just take the cheap imports (a benefit) and pump up the domestic economy through increased public spending on many of the goods and sevices we so sorely lack. Our currency may well drop on its own helping our exports, but even if it doesn’t we’ll have an array of additional public goods and services.

If we want to assist value-added manufacturing rather than further increasing overblown resource exports, we could target certain broad industries useful to our domestic needs, for instance train manufacturing.

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