Quantitative Easing: Should Canadians be worried?May 20, 2021
Quantitative Easing: What is it? What does it do? Should Canadians be worried?
At a recent student event attended by Bank of Canada Governor Tiff Macklem, students were told that certain monetary policy tools, like Quantitative Easing (QE) could potentially help the post-pandemic economic recovery by spurring demand and ultimately job growth.
Unfortunately for taxpayers, this is not the complete picture.
Let’s start from the beginning.
The Bank of Canada (BOC) is the main authority that conducts monetary policy in Canada. After experiencing high inflation in the 1970s and 80s, the government and the BOC decided that they should work to gradually reduce inflation.
The decision to actively work on lowering inflation led to the development of the two per cent inflation target and the operation of the Bank as we know it today.
The BOC’s main tool to combat inflation is setting the policy interest rate, or the rate that major banks charge each other for overnight loans.
Since 1996, the Bank has lowered its rate when inflation was getting too low and raised it when it believed it was getting too high. However, if the BOC wants to help increase inflation but the policy rate is already low, just as it is now, they need to turn to more unconventional monetary policy tools.
Quantitative Easing (QE) is one such unconventional monetary policy tool that Canada has employed extensively during the pandemic.
QE works by having the BOC buy large amounts of government bonds, reaching four billion per week at the height of the pandemic, from large financial institutions and pay for it with credits to their settlement balances.
What are settlement balances, you ask?
Well, settlement balances are the accounts that these financial institutions hold with the Bank of Canada. The BOC holds government bonds as an asset and these settlement balances are considered liabilities.
QE during the pandemic has caused an unprecedented increase in the Bank’s balance sheet. In the week before the pandemic started, the bank had $250 million in settlement balances and in mid-April, that number sits around $312 billion.
What does this mean for taxpayers?
There are two main negative consequences for taxpayers that can occur as a result of quantitative easing; the risk of inflation and unsustainable debt on the backs of taxpayers today and tomorrow.
Some people are right to fear high inflation, as QE can increase the ability for financial institutions to lend out money as a result of their substantially higher balances with the BOC. Even though the first round of QE in the US during the financial crisis failed to produce this excess inflation, we need to remember that the situation today is much worse.
Based on the balance sheet of both the Bank of Canada and the Federal Reserve, we can see that the asset purchases are much larger this time around and if lenders decide to lend and the BOC fails to turn off the expansionary tap, there could be inflationary pressure in the future.
Excessive inflationary pressure could be a real danger as we have already seen inflation above the two per cent target despite ongoing lockdown measures and the related increased unemployment.
And then there’s the very real issue that QE has lulled governments into a false sense of security on the assumption that it now has an increased ability to carry on with deficit spending and thereby increasing taxpayer-supported debt and deficits.
Since QE is pre-announced and financial institutions know that the Bank of Canada will buy their government bonds, they are more likely to buy the bonds themselves as they know the Bank will buy from them in the method described above.
The central banker does not have a problem with these purchases, but the taxpayer should. Such large asset purchases can distort the market and allow the federal government to spend more than usual, increasing both debt and deficits.
The increased ability to borrow as a result of QE is an issue because the government is borrowing at an unprecedented rate. The debt from this borrowing will have to be paid back by this country’s future generations through higher taxes.
Gage Haubrich is the Prairie Regional Director for Generation Screwed
He holds a Bachelors of Economics and will be pursuing a Masters of Economics at the University of Saskatchewan in Fall 2021 .