By Elliott Vavitsas
Through the COVID-19 Pandemic, and as is the case during modern times of economic malaise, central banks worldwide are engaging in programs of quantitative easing. This is where a central bank purchases assets such as long term government bonds, mortgage backed securities, and any other kind of security in order to increase the money supply of the national economy. In turn, quantitative easing is meant to lower interest rates and spur private investment, stimulating growth. Quantitative easing can be declared partly responsible for the economic growth experienced worldwide between 2010-2019, and will certainly play an important part in the next economic recovery. How the Bank of Canada has used it in the past eight months however could amount to something more serious.
Since March, the Bank of Canada has purchased over C$ 180 billion in Government of Canada bonds. More interestingly, the rapid acceleration of government bond purchases coincided with the Canadian Government’s pandemic economic stimulus program. It would seem to be a happy coincidence that the Bank of Canada would add so much money to the government’s balance sheet when it needs it most. In reality this is an indirect form of debt monetization, or in simpler terms “money printing.” When combined with quantitative easing there could be an equilibrium, but the massive amounts of capital needed to recover from the pandemic and keep markets stable makes the bond buying that the Bank of Canada is engaging in lopsided.
How the Bank purchases bonds technically though is not from the government itself. Regular banks hold weekly auctions of government bonds where central banks may purchase them. The rapid purchasing that the Bank of Canada has engaged in however creates a rise in government bond prices, which means that regular banks must purchase them at a higher price, therefore increasing the government’s monetary base. As the Bank of Canada has stated it will continue its quantitative easing program into the foreseeable future, it would not be surprising if the 70-100 billion that Canada plans to spend on economic recovery comes by way of revenue generated from the sale of bonds.
Furthermore, the bonds which the Bank of Canada has purchased are almost all the long term type. When the time comes for repayment it is possible that the government issues new bonds to the bank in order to fulfil their obligations, which would also end up on the Bank of Canada’s balance sheet. This has already been done in the United States and EU, which have issued new bonds to the Federal Reserve and ECB respectively to repay bonds purchased during the recovery from the 2008 financial crisis. This would lead to an increase in the government’s monetary base for the foreseeable future, meaning more physical cash will exist in the economy.
If the Bank of Canada is truly increasing the monetary base and engaging in debt monetization, the risk of inflation and high interest rates becomes more likely. This would sink Justin Trudeau’s plans for high borrowing post pandemic and ravage the country’s finances, not to mention that the Bank of Canada would be left in a risky position, as it has no real timeline for when it can slow down its purchasing or recover its money from these bond purchases. This would create even greater risk in the economy. With the continuation of these measures, a longer recession, or even depression could occur in the future.
To make matters worse, before the pandemic economists and central bankers knew that measures like quantitative easing increases inequality, as the money it injects into the economy is intended for corporations rather than everyday citizens. Through the pandemic this has stayed true; look no further than a fully recovered TSX index and strong Canadian housing market. If the Bank of Canada continues with this program with the cooperation of the federal government, it would worsen inequality in Canada. It could also end up being a political sticking point, as Justin Trudeau campaigned as an ally of the working class. The prospect of increased inequality in the modern political climate could hurt Mr. Trudeau’s Liberal Party’s chances at re-election.
Despite problems, the Bank of Canada should be given credit where it is due. It has been successful in preventing a massive reduction of GDP as witnessed in Europe and has kept most incomes stable. However the next phase will be critical. Getting the Canadian economy back on track is no small task. While the government wants to be the one to lead the charge, perhaps the Bank of Canada should assert itself and take ownership of the next round of stimulus. Scaling back quantitative easing, or at least purchasing less government bonds to a point where debt monetization is not a risk but interest rates stay low would be a good start. This would allow the government to finance its stimulus through proper debt, especially considering Canada’s low debt to GDP ratio. These two strategies would allow for money to flow where it is needed, but also lower the risk of runaway inflation and unemployment in the future. As a result, Canada would be able to plot a course out of the pandemic recession while mitigating future consequences of the massive spending which is required at this moment in time.
The views expressed in this article are the author’s own and may not reflect the opinions of The St Andrews Economist