We’ve understood for a long time in Canada that interest rates are best set at some distance from politicians. Since 1991, when Bank of Canada Governor John Crow and Finance Minister Michael Wilson announced that inflation would guide monetary policy, the government and the central bank have worked out a mutually agreeable arrangement. With one exception, these marching orders have come at five-year intervals. It’s understood that during the intervening years, the Bank of Canada will be left alone to achieve the inflation goal however it sees fit.
This measure of independence was necessary because achieving the new inflation mandate would require winning the public’s trust. A central bank always can slow inflation by strangling economic growth with higher interest rates. But to achieve a certain rate of inflation over time, economic actors must buy in. Competence assuages doubts. So does the understanding that policy will be shielded from the whims of ideological or vote-chasing politicians. The third element is transparency: the Bank of Canada pulled back the curtain on its decision-making process, scheduling eight policy announcements a year and describing each decision in a press release. Canada’s Consumer Price Index has averaged annual increases remarkably close to the central bank’s target of 2%, a testament to sound economic policy and dedicated implementation.
Canada was an early adopter of inflation targeting, which would become the industry standard. Now, as post-crisis monetary policy rapidly evolves, Canada is stuck in the early 2000s. Finance Minister Bill Morneau’s out-of-nowhere decision to curb housing prices last week was a reminder of a serious flaw in the country’s vaunted approach to financial regulation. With official interest rates near a record low to keep the economy from sliding into a deep recession, Ottawa has failed to mount a convincing response to a potential housing bubble and escalating personal debt. Statistics Canada reported December 14 that the ratio of household debt to income climbed to almost 166% in the third quarter—the highest on record and nearly a full percentage point higher than in the same period a year earlier.
It is plainly understood that there is more to economic oversight than stable inflation, flexible exchange rates and balanced budgets. Authorities must also spend considerable time on the lookout for asset-price bubbles. The Bank of Canada on December 15 will release its latest Financial System Review, a publication that comes out twice a year. The document is effectively an early-warning system; an opportunity for the central bank to notify the public of trouble spots in financial markets. Up until recently, the central bank released it with little fanfare. Before the crisis, financial oversight was mostly a sideline. Today, the Bank of Canada has an entire department devoted to the task. Governor Stephen Poloz and his No. 2, Carolyn Wilkins, will hold a press conference after the release of the Financial System Review, a relatively new tradition meant to add weight to the monetary authority’s observations. If it sees trouble, it wants to make sure everyone knows before it’s too late.
The power of the pedestal is the only weapon the Bank of Canada has to guard against financial crises. In some countries, the central bank has the ability to squeeze asset-price bubbles, an adjunct of monetary policy known as macroprudential regulation. In Canada, that power rests with the finance minister.
That always posed a theoretical problem: It subjects decisions such as whether to make it harder to get a mortgage to criteria other than avoiding a financial crisis. We now know the theory holds true in practice. Bloomberg News reported earlier this month that former finance minister Joe Oliver rejected advice from officials that he take steps to restrain soaring house prices. The National Post’s John Ivison wrote that former prime minister Stephen Harper opposed tighter mortgage rules because they would hamper his desire to boost home ownership. These articles appeared ahead of Morneau’s decision to require bigger down payments for insured mortgages on pricier homes. The federal banking regulator and Canada’s housing agency simultaneously took steps of their own to cool the housing market. Prime Minister Justin Trudeau evidently is more open to expert advice than was his predecessor.
Last week, when Poloz unveiled an updated armory of emergency stimulus measures, he begged for calm. He insisted he had no intention of deploying negative interest rates or any other piece of his arsenal. And he said that he hoped the public would take comfort in the fact that its central bank had been doing some hard thinking about how it will handle the next financial crisis, whenever it may come. The Bank of Canada is ready.
But there is little reason the public should feel confident that Ottawa is doing as much as it could be to forestall that crisis. If macroprudential policy now is a complement to monetary policy, why is the decision to deploy it still a purely political one? A committee of senior economic officials—including the Bank of Canada governor and the deputy minister of finance—meet secretly in Ottawa to consider financial regulation. (One assumes this group considered the measures that Oliver reportedly rejected, and Morneau later adopted.) The process is as shadowy as the Bank of Canada’s approach to setting interest rates is transparent.
I am willing to say with confidence that inflation is under control. The housing market? Who knows?
Canadian Business
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