Bank of Canada Rides Over the Hill

Nice to see the Bank of Canada swinging into action the last couple of weeks, pumping many billions of dollars of liquidity into financial markets to ease the sub-prime-inspired credit crunch, and making very hard-nosed statements about its intention to “defend” its desired interest rate regardless of where the markets want to go.

Now that’s my kind of central bank.

So how come the Bank’s actions in this “crisis” (actually, I don’t really think it’s a crisis — see related post for my views on that) are so different from their approach to another financial variable: the exchange rate?

Remember on that score, the Bank’s line is that it only cares about the inflation rate.  Monetary policy can address only one thing: the inflation rate.  If markets (the same markets driving the credit crunch) drive the exchange rate to some unsustainable or harmful level, well that’s an inevitable change we’ll have to live with.

The contrast between action on the credit crunch, and inaction on the exchange rate-inspired manufacturing meltdown, says a whole lot about the nature of the Bank as an institution, and the inherent biases in its supposedly “neutral” policy of targeting inflation (and only inflation) with its actions.

Bank defenders could argue that its highly interventionist defense of its desired interest rate — running explicitly against market pressures — is justified because a credit crunch could create a recession which could push inflation below the 1-3% band.  Those are two very big “coulds” in that sentence.  There’s not likely to be much real spillover from this current financial tempest-in-a-teapot (financial markets have hissy-fits all the time; not since 1929 have those tantrums ever caused an actual recession in North America).  And even if there was a recession, there’s no predictable link between a downturn and a retreat in the inflation rate.  And current inflation conditions. if you took the Bank’s rules seriously, should dictate a tightening of credit, not the opposite.

At any rate, you could make exactly the same arguments above to justify Bank intervention to soften the loonie: negative spillover from hundreds of plant closures could reduce aggregate demand enough to soften inflation.

What this contrast really shows is:

1. The financial industry (which has been calling for help, and getting it) is far more influential than real industry (whose equally desperate pleas have fallen on deaf ears on Wellington St.)

2. The Bank of Canada is a political institution, not a neutral technocratic guiding force.

3. The inflation targeting rule is not really the only thiing that guides the Bank’s actions.

These are very important lessons for progressives to keep in mind as we go about imagining a monetary and financial policy that would address peoples’ needs, rather than financiers’.

Here’s my Globe and Mail column on this subject, including about 200 words that didn’t appear in the print version:

For years I’ve been arguing that the Bank of Canada should intervene in foreign exchange markets to stabilize the Canadian dollar at a sensible, sustainable level.  The toll of the loonie’s flight is immense and still growing – including almost 400,000 lost manufacturing jobs.  The Bank should act to bring it back down.


The Bank’s response has been blunt and unwavering.  They are in the business of controlling inflation, and nothing else.  That focus dictates their actions.  And if manufacturing jobs are disappearing, this represents an “adjustment to change” (Governor David Dodge’s pet phrase) that will ultimately leave us better off.


So imagine how surprised I was to read about the Bank’s rapid and powerful interventions into financial markets last week, attempting to calm the self-inflicted panic that’s been roiling over-extended speculators from Tokyo to Toronto.


The Bank issued a dramatic statement expressing its determination to go to the wall.  It issued over $3 billion in new low-cost loans to soothe frazzled nerves and keep the easy-credit machine out of the ditch – and that was just on Thursday and Friday.  And it signaled in no uncertain terms that there was plenty more where that came from.


Far from sitting back watching the economy “adjust to change,” this drama featured the central bank as cavalry – charging over the hill, just as the hedge fund artists were making their last stand.  I guess the prospect of bankrupt speculators tossed onto the street, forced to find real work, is not the kind of change the Bank has in mind.


Now don’t get me wrong: what the Bank did last week was prudent and important.  The real economic risks posed by these semi-regular outbreaks of panic on the paper markets are often overblown.  Financial bubbles generate precious little real benefit while they are inflating – and they don’t generally cause too much economic damage (on Main Street, as distinct from Bay Street) when they pop, either.  Nevertheless, the risk of a spill-over credit squeeze for borrowers who really matter (consumers and real businesses) is worth addressing.  I support the Bank’s interventions.


What’s got me irked is the obvious contradiction between the Bank’s willingness to ride to the rescue of banks, hedge funds, and private equity dealers, versus its tough-love response to the dislocation of 400,000 factory workers.


What suddenly happened to the bank’s one-note mantra: that it exists to control inflation, all inflation, and nothing but inflation?  There’s nothing in its dramatic actions last week that could be justified by this mandate: that is, by concerns that inflation was suddenly deviating from the Bank’s 2-percent target.  If anything, inflation is pressing upward on the Bank’s zone of comfort, not downward – in which case it should be tightening credit, not tossing around billions in cash.


Instead of controlling inflation, the Bank’s goal here is to prevent the collapse of more speculative funds, and a contagious crisis in bank lending.  This is sensible.  And it’s quite consistent with a broader reading of the Bank’s formal mandate, as specified in the Bank of Canada Act.  It empowers the Bank to “regulate credit and currency in the best interests of the economic life of the nation … and mitigate … fluctuations in the general level of production, trade, prices and employment.”


But by the same token, taking measures to stabilize our currency at a level consistent with the long-run viability of Canadian industry is equally consistent with that broader mandate.  Yet it’s now abundantly clear that a bankrupt hedge fund is more important in the central bank’s eyes than a shuttered factory.


There’s another way in which the current crisis dramatizes the one-sided nature of current monetary policy.  The Bank of Canada only targets consumer price inflation.  It doesn’t try to restrict credit and hence the money supply unless consumer price inflation is accelerating.


If real businesses use cheap credit to invest in too much real production, create too many jobs, and strengthen incomes too rapidly for the Bank’s liking, then it cracks down hard.  But if speculators use cheap credit to fuel a frenzied inflation in paper valuations, that’s no problem.  An average worker can’t get ahead.  But a speculator gets a free pass – even though the “wealth” they create is no more real than the turrets of Hogwarts Castle.


The value of stable inflation, according to the Bank’s world view, is the certainty and confidence it imparts to investors, who will consequently feel batter about making long-term investment commitments.  This claim is laughable in the wake of yet another entirely predictable meltdown in the overheated paper chase.  We’ve had low, stable inflation for 15 years – yet certainty and confidence are clearly in shorter supply than ever.


This selective, one-sided approach to stabilization speaks volumes about the nature of the Bank as an institution, and the biases of the inflation-targeting regime it espouses so passionately.  The Bank of Canada is not a neutral, prescient team of technocrats, guiding us to some imaginary point of maximum efficiency.  Like any other political body, its opinions and actions reflect value judgements about the relative importance of differing, sometimes conflicting goals and interests.  Job creation versus inflation control.  Consumer inflation versus stock market inflation.  Financial troubles versus industrial troubles.


So Governor Dodge, please carry on with your dramatic financial rescue mission.  Just spread a little of that rescue around to the rest of us next time.


  • Excellent post and column! I have to say, I don’t think I’ve seen that one question put out there so clearly. Well done.

  • Good points. And perhaps the Bank should be reminded that the Minister of Finance owns every single share of the Bank of Canada…not hedge funds and private banks.

  • hey Jim, enjoyed your irrational rationality in the globe. I also got the t-shirt, I think it was the one, “I’m with Stupid and Stupid’s with Me”, which I am sure bankers and specultors as both individuals and institutions, be made to wear for the next couple of months. (throw in the central bankers for that matter.)

    Kidding aside, your point that the Bank of Canada is a political body and not some “neutral technocratic force” is something that must be fashioned in a quite serious manner by progressives. One would like to believe that in some optimistic view of the workings of the economy, that a neutral technocratic force could be something that we strive for. We might even aim a bit higher for a worker friendly central bank but lets not get too excited as a neutral one is still a long way off.

    The duality that the current central bank operates within is coming to bear. A contradiction between the publicly perceived neutral one, and the real life- inflation hawk, job killing, wage vapourizing, and destructive smashing of manufacturing assets in Canada.

    Hopefully with some quite loud debate over the next while, given the headlines and public spectacle these financiers and bankers make over the next while, the public will gain some further insight into the most time dark passageways of these institutions that hold so much power over their economic and social endeavors.

    And potentially they will recall these thoughts when filling out a ballot at the voting station.


  • Here is Ted Carmichael of J.P.Morgan, one of Canada’s top private sector economists, on the Bank of Canada’s role in life, as reported in the August 27 Globe and Mail:

    “Carmichael said the central bank has a mandate not only to promote sustainable economic growth and low inflation, but also to keep the financial markets operating smoothly, and that will be the overriding concern in putting further rate hikes on hold. ‘The latter responsibility trumps the former,’ he said.”

    So much for inflation targeting!

  • Another nail in the coffin of inflation targeting, in today’s Globe and Mail editorial:

    “Although the central bank is responsible for inflation control, it should take action only within a climate of sustained growth and smoothly operating markets. The bank is right to recognize that now is not the time to put more pressure on struggling borrowers.”

    In other words, control inflation, but don’t necessarily control inflation.

Leave a Reply

Your email address will not be published. Required fields are marked *