Tiff Macklem, Governor of the Bank of Canada, has no intention of letting go and still wants to decree new interest rate hikes if inflation does not markedly reduce its rise. A stubbornness that is not unanimous among experts, who want more transparency from our central bank as to the repercussions that its decisions can have.
Throughout the past year, inflation has been at the heart of everyone’s concerns, from households that have had to deal with steep price increases for housing, food and travel, to businesses that have to bear higher financing costs due to successive increases in interest rates.
A situation that might have been partly avoided or at least mitigated if the federal government and the Bank of Canada had better managed the exit from the crisis of the COVID-19 pandemic from 2021.
This is what we learn from a report by the Standing Senate Committee on Banking, Trade and the Economy, which gathered this fall the testimony of some twenty economists and specialists with the aim of better understanding the state of the Canadian economy in the context of high inflation that we experienced last year.
A context that has led to eight consecutive increases in the Bank of Canada’s key rate since last March.
Experts who testified include Robert Kavcic, Senior Economist at the Bank of Montreal, former Governors of the Bank of Canada David Dodge and Mark Carney, Steve Hanke, Professor of Applied Economics at Johns Hopkins University, Pierre Fortin, professor emeritus of economics at UQAM, and Jean-François Perrault, chief economist at Scotiabank.
Several different points of view emerge in this report to explain the genesis of the inflationary context that we observe today, but several of the opinions converge to point to the action of the Bank of Canada and the federal government as important sources which led to the current context.
The causes of inflation have long been sought in the wrong places; the pandemic, the supply chain malfunction, the Russian invasion of Ukraine, but according to economist Steve Hanke, it was essentially the excessive growth of the money supply that led to the situation we know.
During the pandemic, the Bank of Canada intervened massively to inject money into the system while the federal government was spending hundreds of billions to relieve the devastating effects of the health crisis on the population and businesses.
All the specialists who testified before the Committee agree that this massive financial support was necessary and even indispensable. Many believe, however, that this aid was stretched out over too long a period and that it was quickly poorly targeted.
Undeniable effects
Professor Hanke points out that since 2020, 46% of the money supply is attributable to the Bank of Canada, while this rate was 3% from 2010 to 2020.
John Greenwood, chief economist at International Monetary Monitor, points out that when the central bank finances the government deficit by increasing the money supply, both the government and the private sector spend more on goods and services, which increases inflation.
Federal spending has increased by 73% in 2020-2021 and will still be 27% higher in 2022-2023 compared to its 2019 level. The federal deficit is expected to represent 1.5% of Canadian GDP in 2022-2023, points out the report of the Senate Committee.
“In light of the testimony we have collected, the Bank of Canada must be more transparent in its decisions. When it increases the money supply, it generates inflation, and when it increases interest rates, it slows down the economy.
“It is certain that if we kill the economy, there will be no more inflation. The Bank of Canada must better explain how its actions will impact the economy,” observes Senator Diane Bellemare, former professor of economics at UQAM and member of the Standing Senate Committee on Banking, Commerce and the Economy.
As we know, it takes 12 to 18 months before an interest rate hike has an effect on economic activity.
The eight hikes in the key rate have not yet had their full impact on general activity, but they are already affecting the housing sector, where house prices are expected to correct 25%, according to the economist of Scotiabank, Jean-Francois Perreault.
Rising interest rates are also slowing new housing starts at a time when there is currently a generalized shortage in the country, fueled by the arrival of more than 400,000 new immigrants each year in Canada.
“Sometimes it feels like the Bank of Canada is prescribing systemic chemotherapy to attack a localized cancer. We need to be better able to assess what the effects of rate increases will be before decreeing new ones,” said Senator Bellemare.
