With the COVID-19 recession getting deeper by the day, the Bank of Canada has joined other central banks in quickly reducing its target interest rate to near zero and implementing “quantitative easing” (QE) measures to suppress other interest rates and support credit flows, including borrowing by government.
Starting April 1, the bank commenced buying at least $5 billion of Government of Canada bonds every week. And the bank pledged to continue that weekly pace until the economy was well into its eventual post-pandemic recovery. The QE program will thus likely continue for at least a year, adding $250 billion or more to the bank’s already substantial holdings of federal bonds.
As of March 2020 (before the start of QE), the Bank of Canada already owned over $100 billion worth of federal government debt (about 15% of the total outstanding). Those holdings are now set to more than triple over the coming year—by an amount broadly equivalent to the humungous budget deficit the government will incur over the same period.
Other central banks are doing the same thing, many even more aggressively. For example, the U.S. Federal Reserve has announced an unlimited QE program, worth trillions of dollars, to buy a huge range of different assets: government bonds, corporate bonds, mortgage-related securities, and special new bonds to provide lending to small and medium-sized businesses. The Fed says it will do whatever is necessary to keep interest rates for all lending as low as possible, and keep credit flowing.
Until recently, the idea of central banks directly intervening in credit creation like this was considered sacrilegious by mainstream economists. And it still causes some to shudder with fear, sparking frightening visions of hyperinflation, fiscal profligacy and people needing wheelbarrows full of money to buy a loaf of bread.
But in fact, QE has been a standard item in the toolbox of central bankers for over a decade. Many central banks, including those in the U.S., EU and U.K., began using it widely after the Global Financial Crisis (GFC) of 2008-09. Japan has been doing it since 2001.
Quantitative easing was first used because conventional monetary policy ran out of ammunition. During the GFC, interest rates were cut to zero and in some countries eventually fell below zero. More cuts in target overnight rates (the traditional way for central banks to encourage more spending by consumers and businesses) were impossible. And interest rate cuts weren’t really working, anyway. Shell-shocked consumers and businesses didn’t really want to borrow, even at rock-bottom rates, so reducing interest rates was like pushing on a string.
So central bankers looked for another way to stimulate economic activity: they began to purchase financial assets, using money that they themselves created. They bought huge quantities of government bonds, corporate bonds, mortgage-backed securities and even corporate equities (shares). The idea was to put more money into the hands of the institutions and investors that issue or formerly owned those assets. Those institutions and investors, it was said, would spend that extra cash, or loan it out, thus sparking more economic activity.
The Bank of Canada did not participate in those initial rounds of QE. It cut its target interest rate to near zero and offered emergency liquidity assistance to private banks. This time, however, the Bank of Canada has jumped on the QE bandwagon with both feet.
Buying assets with money you create yourself is certainly a neat trick. When central banks buy financial assets from private investors, those investors get a new deposit in their bank account, and their bank gets new funds in its deposit account at the central bank. If the central bank buys assets (like bonds) directly from government, then it just credits the government’s deposit account with the Bank of Canada, which it uses in the course of its normal financial operations.
Either way, money is created out of thin air. That’s different from conventional expansionary monetary policy, whereby the central bank tries to induce private banks to create new money, inducing borrowers to take out additional loans with lower interest rates, and thus stimulate more consumer and business spending. Indeed, it’s important to keep in mind that any bank creates money whenever it issues a new loan—so there’s nothing particularly magical or unusual about the central bank doing this. Private banks don’t need depositors to issue new loans. They create money when they issue a loan and credit the borrower’s deposit account accordingly.
How does that turn into actual cash, given that private banks can’t actually print banknotes? In our largely electronic credit-money system, most loans are never converted into actual cash. Rather, payments across the economy (between borrowers and lenders, buyers and sellers) are simply netted out every day at a clearinghouse through routine balance settlements. If any particular bank ends in a negative position at the clearinghouse—because their cash outflows on a day exceed their cash inflows—it just borrows from other banks through routine overnight lending flows. (It was the freezing up of those inter-bank loans in the worst days of the GFC that caused the collapse of some banks in other countries; in Canada, the inter-bank system is supported and insured by the Bank of Canada, and hence was more stable.)
So the central bank is simply doing what private banks do every day: creating new money by advancing credit (by buying a bond or other asset) and/or taking over loans (and associated assets) from other lenders, namely, the institutions or investors which already owned them.
There are two broad ways for the central bank to do this. If it purchases the bond directly from the institution issuing it (like a government), this is called a primary purchase. If it purchases the bond from another investor or institution after it was first issued, this is called a secondary purchase. The Bank of Canada does both of these things. Its $5 billion weekly purchases will all be in the secondary market, but some of its other asset purchases, such as its plan to buy housing bonds from the CMHC, will be in primary markets.
Unfortunately, QE in secondary markets is a very indirect way to push new money into the economy—one that is hardly neutral in its distributional effects. By buying existing assets from other investors, the central bank puts its newly created money into the hands of existing wealth-holders: banks, other financial institutions such as mutual funds or money market funds, large corporations, and ultimately the shareholders of those companies. The hope is those wealth-holders will then spend in ways that stimulate new production and employment.
This is a very indirect and very biased form of economic stimulus. Post-GFC QE in other countries contributed to the run-up of asset prices in recent years, with regressive distributional impacts (e.g., those gains were rightly concentrated among the wealth-owning elite of society). It had less obvious impacts on real employment and production. But it certainly facilitated continued deficits by governments, by keeping interest rates, even for longer-run bonds, very low.
I can think of far more deserving recipients of publicly created money. And I can think of far more direct ways to use it to stimulate actual production and work.
For instance, primary purchases of federal government bonds are more effective, because they put newly created money at the disposal of governments, which in turn use it to pay for spending on investments or services. That spending is the most powerful way of supporting jobs and incomes during economic downturns—and it will be absolutely vital in helping Canada recover from the current economic catastrophe.
Conventional economists are especially leery of this approach, claiming it would give profligate governments a “blank cheque” to spend without limit. And the Bank of Canada tries to downplay this aspect of its QE program. It describes its QE measures as being aimed merely at “making credit affordable and available” and “achieving our primary mandate of keeping inflation close to target.”
But in fact, the Bank of Canada has routinely bought government bonds in the primary market for decades, so that genie is already out of the bottle—with none of the dramatic consequences, including a complete breakdown of fiscal discipline, predicted by the skeptics. And whether the bank purchases them on the primary or secondary markets, its QE strategy suppresses interest rates on government bonds (and by extension on private borrowing, too) and thus facilitates virtually unlimited federal borrowing.
Therefore, the bank’s QE program will stabilize interest rates, reduce the risk of financial panic and, along with its other liquidity programs, reduce the possibility of a credit freeze. It will support the federal government’s efforts to finance the large deficits (and accumulating debt) of coming years. Those deficits will result partly from expensive programs introduced to support Canadians and the economy (like the $71 billion wage subsidy program announced in late March), and partly from declines in government revenues arising from the recession.
The Bank of Canada also plans to purchase mortgage bonds from the Canada Mortgage and Housing Corporation, and provincial government bonds (again with the goal of keeping interest rates low and forestalling financial market instability), as those bodies also take on much more debt in the months ahead. The bank even has the authority to make direct loans to provincial governments.
Some conservative economists fear QE will inevitably cause a big acceleration in inflation. This fear stems from the old-fashioned, disproven monetarist idea that inflation is caused by an excessive quantity of money in the economy (“too much money chasing too few goods”). But the experience of the last decade should lay that fear to rest once and for all.
QE led to the creation of huge amounts of money in the world’s biggest economies after 2008, on top of the even larger amounts of money created routinely through private bank lending. Far from taking off, inflation remained too low, even according to the central banks’ own strict targets. Inflation remained weak because most industrial economies also remained weak, struggling to shake off the painful hangover of the GFC and subsequent problems like the European debt crisis. Now another massive crisis has hit the global economy before we even fully recovered from the last one.
If inflation ever got “too high,” a problem that seems hard to imagine at present, central banks would respond with higher interest rates, by raising their target interest rates, or by “unwinding” some of their previous asset purchases, in effect selling those assets back to financial investors and taking money out of the economy. In practice, that latter response—“quantitative tightening”—has never really happened. World financial investors became accustomed to steady inflows of newly created public money. Even when the U.S. Fed just announced that it planned to reduce its asset holdings (by letting its stock of acquired bonds mature, or selling them back into secondary markets), financial markets shuddered.
Indeed, from 2008 through 2020 (and the onset of this new crisis), the four biggest central banks (U.S., Europe, Japan and U.K.) made asset purchases averaging over 3% of their combined GDP per year. In only a handful of months through that entire period did the total amount of assets held by the four banks ever decline, and then only slightly. Now those asset holdings are poised for a massive expansion, bigger and likely longer lasting than the purchases that followed the GFC.
So in practice, QE has been pretty much a one-way street. Central banks purchased huge quantities of financial assets and haven’t found it easy to get rid of them. For government bonds, that means when they come due, the central bank simply rolls them over. In this way, as long as central banks keep interest rates low, governments can finance even large public debts in perpetuity.
In Japan, for example, ongoing QE has underpinned the steady expansion of public debt there, now equivalent to over 250% of GDP. Contrary to traditional fear-mongering, this hasn’t sparked financial meltdown or national bankruptcy. Japan hasn’t “hit a debt wall.” Interest rates haven’t skyrocketed, due to government borrowing “sucking up” available capital, or investor fears about default. That’s because the supply of funds capital is actually unlimited, thanks to the central bank’s ongoing actions.
QE has thus made it easy to finance Japan’s ongoing fiscal deficits, which in turn have been important in addressing other macroeconomic problems there, including an ageing, shrinking population, long-term real estate deflation, and rebuilding after the 2011 earthquake and tsunami. And if anything, inflation in Japan has remained too low throughout this whole period.
This previous global experience with QE is very important in the current context. The Bank of Canada’s adoption of QE will shape how the coming increase in federal debt and deficits is managed—both fiscally and politically. The loss of revenue resulting from the shock decline in economic activity, combined with the enormous cost of COVID-fighting measures (in both the health and economic spheres), will create very large deficits for the federal government, likely in the order of 10% of GDP (over $200 billion) or more.
So far, knee-jerk concerns about government red ink, mortgaging the next generation, hitting the debt wall, etc., have been largely absent from Canadian policy discussions. Even conservatives understand government must do everything in its power right now to protect Canadians from coronavirus. No one wants “smaller government” in the midst of a pandemic. And even conservative economists implicitly accept the federal government has sufficient fiscal capacity to pay for those emergency measures.
However, we can expect the debt hawks to come out of the woodwork as soon as it’s safe to leave our homes and go back to work. They will invoke old lines about needing to balance the books, pay down debt, act just like a prudent household and live within our means. These arguments will resurface not because there is any real financial constraint on government’s ability to sustain increased spending. Rather, debt and deficit fears will be rejuvenated as the stalking horse for a deeper right-wing drive to retrench government’s power and return economic leadership to the business sector.
Progressives must be ready to resist these predictable calls for renewed austerity that will arise as soon as the immediate health crisis has passed. This means first and foremost building strong public support for the things we want government to keep doing:
- Strengthening the broader health care system, including aged care, which proved to be the weakest link in the health care chain due to decades of underfunding, privatization and precarious labour strategies.
- Repairing and renewing income support programs weakened by the emergence of non-standard and insecure work.
- Sustained investment in public infrastructure of all kinds including health care facilities, other public service facilities, transportation and sustainable energy systems.
- A permanent expansion of public, caring and community services to strengthen well-being and social inclusion after this disaster.
- Major direct public sector hiring to help address mass unemployment after the pandemic.
Indeed, the Bank of Canada’s QE strategy could be expanded and strengthened in several important ways:
- The bank should expand its purchases of newly issued federal bonds (in the “primary” market). It routinely purchases a share of all new federal bond issues anyway, as part of its normal monetary policy operations. It should buy even more as part of the QE strategy. This cuts out the intermediary role of banks, dealers and private investors, and directly channels newly created funds to the government.
- Lower levels of government deliver most of the direct public services that Canadians need. Their budgets will also be thrown into disarray by the crisis, but they have fewer fiscal tools at their disposal than the federal government does. The bank should expand its purchases of provincial bonds (including primary issues) to keep interest rates for provincial borrowing very low. The bank should also develop a system for purchasing municipal bonds.
- The Bank of Canada can follow the U.S. Fed’s lead in imagining QE strategies that could directly provide financial support to targeted businesses and industries. One example would be helping to capitalize (through bond purchases) a publicly owned Canadian sustainable investment bank, to provide funding for new projects in renewable energy development as part of a broader post-pandemic reconstruction program.
- The bank’s monetary policy mandate should be clarified and expanded to explicitly acknowledge the bank's role in guiding the economy toward full employment, including by supporting governments’ fiscal, investment and employment measures. The bank’s current inflation control mandate is to be renewed in 2021 (presumably for another five years). At present, all its actions are supposedly directed at keeping inflation at or near 2%, but since the GFC, that description of the bank’s role has become a polite fiction. In practice the bank now does many other things, independent from or even at odds with that inflation target, to support financial stability, economic growth and job creation. It justifies those broader interventions, including its current QE strategy, with the unconvincing claim that those things are necessary to keep inflation at 2% (rather than lower). This is not true. There’s never been a reliable connection between changes in unemployment and changes in inflation, and the relationship between the two has become even weaker in recent years. Clearly the bank does things to support the economy because it recognizes those actions are essential—not because they are (indirectly) a prerequisite for meeting the inflation target. It would be more honest, and would cement the bank’s responsibility to take action in situations like the present crisis, if its mandate was clarified to explicitly include supporting full employment, including by facilitating government fiscal injections when needed.
Status quo institutions and policy-makers, including the bank itself, are uncomfortable with the broader potential ramifications of QE. Progressives should push to cement this practice, and strengthen it, so governments at all levels, now and in the future, can better mobilize the power of money creation to pay for the services, jobs and investments we’ll need to recover from this catastrophe.
Jim Stanford is economist and director of the Centre for Future Work. He thanks, without implication, Marc Lavoie, Mario Seccareccia, Louis-Phillipe Rochon, David Macdonald, Marc Lee, and Iglika Ivanova for helpful input on an earlier draft.