Poilievre's attack on the governor of the Bank of Canada might be great for riling up his supporters, but it is bad policy that ignores history.
Pierre Poilievre promised in Wednesday night’s Conservative leadership debate to fire the governor of the Bank of Canada when he becomes prime minister. In a debate in which many unusual things were said, this was probably the most shocking. And former Quebec premier Jean Charest was right when he said that making such claims is irresponsible because it undermines the effectiveness and credibility of an important Canadian institution.
Poilievre is correct that Canada’s current high inflation is a serious problem, and his many supporters no doubt liked what he said, especially because it aligns with his ongoing schtick blaming the elite “gatekeepers” who are evidently working against the interests of normal people. Since lots of normal people already dislike commercial bankers, maybe it’s easy to convince them that central bankers are even worse. Especially if they don’t really understand what central bankers do, and why.
Poilievre and his supporters should understand that this highly charged rhetoric makes things worse in this country, not better. And not just for Bank of Canada Governor Tiff Macklem and his colleagues, but for all of us. To understand why, we need to review a little history about central banking.
Banking on a Little History
Back in the 1950s and 1960s, most central banks operated almost like departments of government, where their activities were closely overseen by elected government officials, and their mandates were interwoven with those of the government of the day. Over many countries and many years, it eventually became apparent that countries in which central banks had more operational independence from governments tended to have lower inflation; and countries in which central banks were closely integrated into the government activities had higher inflation.
It is not hard to see why such an “inflation bias” would occur. Elected leaders naturally like the prospects of getting re-elected, and they are smart enough to know that if the economy is very strong in the few months or quarters prior to an election, there is a much better chance of securing a victory at the polls. So, the incentive for elected leaders to pressure the central bank to reduce interest rates a year or so before an election is strong; as it turned out, these incentives were so strong that they were rarely resisted.
But here’s the problem. Lower interest rates in the short run stimulate the economy in ways that are hard to miss, with higher employment, investment and output. After the economy fully adjusts, however, the longer-run effects of the monetary expansion show no permanent gains on employment and output — but the rate of inflation is higher than before. So as politicians played this game over more and more election cycles, inflation ratcheted up.
Eventually, after inflation had increased for several years and was recognized to be a serious problem for the economy, policymakers came to the realization that the way to prevent this inflation bias was to ensure operational independence of the central bank. The government could specify the mandate for its central bank, but then step back and provide the bank with the independence to conduct its policy in the way it saw fit. Since the central bank would then not be exposed to political pressures, it was easier to operate a policy to pursue low and stable inflation.
In Canada, this all happened after the Coyne Affair of the early 1960s, when Governor James Coyne was fired by the Diefenbaker government over a fundamental disagreement about monetary policy. His replacement insisted on a re-writing of the Bank of Canada Act to guarantee the Bank’s future operational independence. In the early 1990s, the system was improved further by the Canadian government and the Bank of Canada agreeing on the Bank’s primary objective of targeting two-per cent inflation, an agreement that has been renewed every five years. Once the government and the Bank agree on the specific inflation target, the Bank is left alone to use its expertise and judgment to achieve that target in the most effective way it chooses.
Over the past 30 years or so, Canadian politicians have largely respected the operational independence of the Bank of Canada. Maybe they fully understand the underlying logic, or maybe they don’t. But for whatever reason, our leaders have resisted making statements to politicize the Bank of Canada or its governor.
Inflation on the Rise
It is possible that it has been easy for them to hold their tongues since Canadian inflation has been so low and stable for the last 30 years. But today we are in a new world, with inflation up and rising. And Pierre Poilievre is not only against high inflation — as all of us should be — but he is openly taking pot shots at the Bank and at Governor Tiff Macklem.
The first is that today’s inflation has several underlying causes, only some of which can be influenced by central-bank actions. To blame the current Bank of Canada governor demonstrates a serious lack of understanding of the inflation process. The disruption of global supply chains is the first cause, and that cannot be corrected with any monetary policy. The second cause is pent-up demand coming from the millions of people across Canada who were lucky enough to maintain their jobs and incomes throughout the pandemic, but were unable to spend. Now that vaccines are in and masks are down, these people desperately want to go out to restaurants, movies, retail stores, vacations and so on. And no reasonable increase in interest rates will dampen their enthusiasm (though it would take some steam out of an over-heated housing market, and this would be good). The third cause of inflation is the war in Ukraine, which has pushed up the world prices for lots of commodities, including gasoline and many important food items. Nothing the Bank of Canada can do will have any effect on those prices.
The final cause of inflation — which is more of an issue for the next few years rather than the last one — is the massive expansion of money that has been engineered by the Bank of Canada over the past two years as its emergency response to the pandemic. Poilievre is correct that the Bank has created a massive amount of money (roughly $400 billion) over the past two years, but he is wrong in thinking that this new money is to blame for the inflation we are now experiencing. The lion’s share of this new money is currently residing in the commercial banks’ reserve accounts at the Bank of Canada, earning a very low rate of interest. It is only once these funds start fuelling a massive growth in credit that they will add significantly to inflationary pressures, and that is exactly why Governor Macklem has committed to pulling these funds back by shrinking the Bank’s balance sheet.
Has Politics Entered the Bank?
The second reason why Poilievre’s rhetoric is irresponsible is that by the mere act of politicizing the Bank and the governor, it forces all of us to wonder what motivations are truly lying beneath whatever actions the Bank takes next. If Macklem responds to Poilievre’s statements and publicly disagrees, does that make him a Liberal? If he makes a policy decision which appears to align with Poilievre’s world view, does that make him a Conservative? If he ignores Poilievre altogether (which is what I recommend), does this make him a heartless central banker who doesn’t care about normal people?
In general, once statements like this are openly made, we are all led to wonder whether politics is making its way into the Bank of Canada, and whether this means any change in the Bank’s policy priorities. Is it still committed to two-per cent inflation? Is the commitment as strong as before? What should we be expecting about the future?
Canadians are right to worry about high inflation and to wonder about when it will be put back in its box, and how. But the design and implementation of monetary policy is a tough job at the best of times, and these are far worse than the best of times — with an economy that is now recovering from a massive pandemic recession and an inflationary outlook that is far more complex and confusing than is usually the case.
This is no time to take cheap political shots at one of Canada’s most successful economic institutions. The Bank of Canada and Governor Tiff Macklem deserve to be left out of today’s political debates. We will all benefit if they are.
This article was originally published in The Line, May 13, 2022.
About the author
Chris Ragan is an Associate Professor and the founding Director of McGill University’s Max Bell School of Public Policy.
Ragan was the Chair of Canada’s Ecofiscal Commission, which launched in November 2014 with a 5-year horizon to identify policy options to improve environmental and economic performance in Canada. He was also a member of the federal finance minister’s Advisory Council on Economic Growth, which operated from early 2016 to mid 2019. During 2010-12 he was the President of the Ottawa Economics Association. From 2010-13, Ragan held the David Dodge Chair in Monetary Policy at the C.D. Howe Institute, and for many years was a member of the Institute’s Monetary Policy Council. In 2009-10, Ragan served as the Clifford Clark Visiting Economist at Finance Canada; in 2004-05 he served as Special Advisor to the Governor of the Bank of Canada.
Chris Ragan’s published research focuses mostly on the conduct of macroeconomic policy. His 2004 book, co-edited with William Watson, is called Is the Debt War Over? In 2007 he published A Canadian Priorities Agenda, co-edited with Jeremy Leonard and France St-Hilaire from the Institute for Research on Public Policy. The Ecofiscal Commission’s The Way Forward (2015) was awarded the prestigious Doug Purvis Memorial Prize for the best work in Canadian economic policy.
Ragan is an enthusiastic teacher and public communicator. In 2007 he was awarded the Noel Fieldhouse teaching prize at McGill. He is the author of Economics (formerly co-authored with Richard Lipsey), which after sixteen editions is still the most widely used introductory economics textbook in Canada. Ragan also writes frequent columns for newspapers, most often in The Globe and Mail. He teaches in several MBA and Executive MBA programs, including at McGill, EDHEC in France, and in special courses offered by McKinsey & Company. He gives dozens of public speeches every year.
Ragan received his B.A. (Honours) in economics in 1984 from the University of Victoria and his M.A. in economics from Queen’s University in 1985. He then moved to Cambridge, Massachusetts where he completed his Ph.D. in economics at M.I.T. in 1989.