Don Quixote Poilievre goes to war

Like Don Quixote fighting at the windmills, Conservative leadership candidate Pierre Poilievre attacks the Bank of Canada and demands the head of its governor, Tiff Macklem, accusing him of doing the dirty deeds of Prime Minister Justin Trudeau .

If by chance Mr. Poilievre succeeded, he would precipitate a serious crisis of confidence in the central bank, like that of the Coyne affair in 1961, with no less serious consequences for the country’s reputation.

At the time, a dispute between James Coyne and Conservative Prime Minister John Diefenbaker forced the governor’s resignation. His successor, Louis Rasminsky, however, obtained an amendment to the Bank’s law, enshrining its operational independence, but reserving the possibility for the Minister to give it written instructions, which must be tabled in Parliament.

The governor and minister have regular private talks, but to date no disagreement has warranted such instructions, which are sure to prompt another resignation and shake market confidence.

Mr. Poilievre criticizes the Bank for having caused the current inflationary pressure by the reckless purchase of bonds, in order to finance the government’s spending sprees. The Bank has not acted independently and its Governor must be fired, regardless of his irremovable seven-year term.

A nuanced independence

It is legitimate for elected officials to have their say on the main objective of the institution. The government and the Bank have jointly set the inflation target at 2%, renewed every five years for 30 years, under both the Conservatives and the Liberals.

However, experience has shown that it is wiser to let central banks choose the means to reach the target. It is all too tempting for politicians to delay raising interest rates or to limit their magnitude, decisions that are always unpopular, but sometimes necessary to tame inflation.

Look at Turkey, where President Erdoğan is tying the hands of his central bank, despite 70% inflation!

In my 17 years on the Monetary Policy Review Committee, chaired in turn by Governors David Dodge, Mark Carney and Stephen Poloz, no one has ever invoked a government preference for a decision on interest rate.

Only economic and financial considerations were taken into account.

However, the Bank does not enjoy the same independence in its other roles. In terms of financial stability, responsibility is shared with the Ministère des Finances, the Office of the Superintendent of Financial Institutions, the Deposit Insurance Corporation and the major provincial securities commissions, including the Autorité des marchés financiers.

But only the Bank can create unlimited liquidity that can keep markets running smoothly in times of crisis or help a bank facing a run on its deposits. Its loans are always granted against solid guarantees.

The Bank of Canada is also the federal government’s fiscal agent. It advises him, but follows his instructions for the management of its liquidities, foreign exchange reserves and the issue of its bonds.

It enjoys great autonomy for the design of banknotes, but the government chooses the historical figures and the symbols that illustrate them.

But in terms of the conduct of monetary policy, the Bank enjoys absolute independence, although it comes with a duty of transparency and accountability. Formerly secretive, central banks today strive to explain their views in the public square and expose themselves to all criticism, including the most far-fetched from Mr. Poilievre.

Policy coordination

The two major complementary levers of economic stabilization are monetary policy, which is the responsibility of the central bank, and fiscal policy, which is the responsibility of the federal and provincial governments. The Bank of Canada incorporates the anticipated effect of budget announcements into its models in order to calibrate its key rate. The government decides on taxes and expenditures; the Bank adjusts accordingly.

The implicit rule of this division of responsibilities is that the governor does not comment on the appropriateness of the decisions of the Minister of Finance and that the latter refrains from commenting publicly on the decisions of the Bank.

The great containment of COVID-19 required exceptional, fortunately complementary, measures everywhere in the world. Here, the federal government has opened the floodgates to support the income of individuals and businesses and assist the provinces struggling with an explosion in health care spending.

The Bank of Canada lowered its key rate close to zero and made massive purchases of bonds on the secondary market in order to ensure market liquidity, then reduced rates on all maturities. Its goal: to limit the damage, then to promote recovery. Facilitating government borrowing was a side effect, albeit beneficial.

Remember that the economy was sinking rapidly and that prices were falling, raising fears of deflation, from which it would have been difficult to extricate ourselves.

High global inflation therefore came as a surprise at the end of this unprecedented crisis. Pent-up consumer demand has rebounded rapidly with deconfinement and production lines remain disrupted by the pandemic. Added now is a shock to the prices of energy, metals and staple foods caused by the war in Ukraine.

The purchase of about $400 billion of federal bonds denounced by Mr. Poilievre was an important part of the monetary stimulus, which the Bank is now working to reverse. But since most of this money is found in the form of reserves that commercial banks have in their accounts at the Bank of Canada, it does not contribute anything to the rise in prices.

Inflation over the past 30 years has averaged remarkably close to 2%. The current jump threatens the credibility of the Bank of Canada, but it doesn’t need sweeping criticism to tackle inflation. It’s in his DNA.