The Financial Post is a good place to start looking for answers. Our answer initiative puts readers in the driver's seat: you submit questions and our reporters find answers for all of our readers. We discuss the Bank of Canada's balance sheet.
The Financial Post is part of Postmedia Network Inc. There was an issue with signing you up. Try again.
The Financial Post is part of Postmedia Network Inc.By clicking on the sign up button you consent to receive the above newsletter from Postmedia Network Inc. You may unsubscribe any time by clicking on the unsubscribe link at the bottom of our emails. Postmedia Network Inc. | 365 Bloor Street East, Toronto, Ontario, M4W 3L4 | 416-383-2300
There was an issue with signing you up. Try again.
The news that the Bank of Canada is about to record losses for the first time in its 87-year history was only reported because it was.
The Bank of Canada's balance sheet can be watched to see how the central bank's assets and liabilities have changed. The central bank was forced to acknowledge in an article published in September that its net interest income was on track to be negative. A few days later, the Financial Post published a report of its own. A story was published by the Globe and Mail.
Macklem's concession that he was about to become the overseer of a money losing operation was one of the most read articles on the Financial Post's website. A subject that involves accounting raises questions about the Bank of Canada's credibility and independence, and raises even more questions about the long-term implications of the central bank's ballooning liabilities. We tried our best to give you the information you need.
Royal Bank of Canada and Bank of Nova Scotia are not the Bank of Canada. Its legislative mission is to regulate credit and currency in the best interests of the economic life of the nation and to control and protect the external value of the national monetary unit.
The lack of a profit motive doesn't mean the central bank's founding fathers were indifferent to losses
Private lenders need to keep enough money at the central bank to clear large payments, but they can usually find more profitable uses for it elsewhere, so they usually don't keep any more money at the Bank of Canada. The Bank of Canada uses this method to reinforce its interest rate. The effective floor for the rest of the financial system is the amount that the central bank is willing to pay on deposits.
The Bank of Canada blew up this comfortable equilibrium because of the crisis. They dropped the benchmark interest rate to 0.25 per cent but felt that wouldn't be enough to keep fear from spreading through financial markets and causing serious harm to the economy. Stephen Poloz, who was nearing the end of his term as governor, decided to use the central bank's power to create money and began buying government bonds from private lenders.
Quantitative easing is called the strategy by economists. It allows central banks to provide a source of cash when financial institutions are afraid of letting go of their cash in order to keep the financial markets calm. Increasing the demand for safe assets causes investors who are crowded out by the central bank's purchases to look for riskier assets. If the Fed had acted sooner, the damage to the economy would have been less severe. The Bank of Canada created $5-billion worth of settlement balances per week to purchase government debt from the big financial institutions that are approved to deposit funds at the central bank
The asset side of the balance sheet peaked at $575 billion. The value of assets it purchased at depressed prices during a panic rose in value as the economy got back to normal. The economy of the nation was threatened by inflation. Macklem has been raising interest rates as aggressively as he was buying bonds during the recession, lifting the benchmark interest rate to 3.75 per cent through October from 0.25 per cent in March, while stating repeatedly in the weeks since his most recent increase that he isn't finished
The consumer price index increased 6.9 per cent in October from a year earlier, down from 8.1 per cent in the summer, but it's still up from a year ago.
The cost of holding all those bank deposits now exceeds the value of the central bank's assets as a result of the rate hike. The central bank loaded up its balance sheet with bonds because it knew it was exposing itself to more financial risk. Monetary policy isn't magic, or at least not magic enough to defy the real world power of accounting principles
The answer depends on how much you trust the technocrats who have been hired.
The Bank of Canada's losses are large and have no bearing on the central bank's efforts to contain inflation, according to Macklem.
Macklem said that low inflation is a good thing. He said that monetary policy was run to deliver low and stable inflation.
Everyone knows that not everyone trusts the technocrats who have been hired to manage the affairs of the nation. During his campaign to become leader of the opposition, Pierre Poilievre promised to fire Macklem if he won the next election. The central bank is still a foil in his attacks on Prime Minister Trudeau and the establishment.
Poilievre told the Empire Club in Toronto that Trudeau was borrowing too much money because there wasn't enough money to lend. If the market mechanism had allowed supply and demand to move the bond yields up as you would normally expect, he would have been able to say he was doing it at record low rates.
Concerns about the Bank of Canada's independence could be raised due to the size of losses that will be the responsibility of taxpayers. Macklem assured the finance committee that the losses would be temporary, but red ink could make for an easy way for critics to question the central bank's credibility. Both Conservative and New Democratic politicians have been attacking Macklem and the Bank of Canada.
Conservatives showed how far they would go in their criticism of Macklem. Andrew Scheer used most of the time allotted to his party for questions. At one point, Macklem was asked if he thought the bonuses earned by Bank of Canada staff were inflationary.
Less absurd, but still unfair, was the question of whether or not the country's already profitable banks would be enriched by the introduction of quantitative easing. There was a spread because the Bank of Canada bought the debt in the secondary bond market. Buying from the source would have meant buying from the Bank of Canada.
The Bank of Canada's credibility as an institution focused on households, rather than the needs of the corporate elite was shot down by the Conservative leader.
There is no fix without government intervention because the Bank of Canada Act prevents the governor from reserve net income when there is a surplus. When she testified at the finance committee on Nov. 28, Freeland didn't say anything about what she was going to do.
The law needs to be changed so that the Bank of Canada can keep its earnings. It would be possible for officials to book losses on the understanding that they will be paid later.
GAAP accounting standards allowed the Fed to turn negative equity into a deferred asset, which will run down over time as earnings turn positive.
The governments of other central banks have shifted the losses to taxpayers. Carolyn Rogers, a senior deputy, told the finance committee that the Bank of Canada has an indemnity from the Trudeau government, but it only covers market losses on the assets purchased during the Quantitative Easing program. She said that another option would be to extend the range of the existing indemnity.
Rogers said that it was a decision for the government. Right now, they are working on it. They will make a decision in the future.
The C.D. Howe Institute published a report last week suggesting that the law be changed to allow the central bank to book deferred assets. Changes to the financial system could force the central bank to carry more assets on its balance sheet than in the past. The risk of losses would go up.
Macklem said he would like to use the Bank of Canada'sprofits in some way to fill in the deficits, but he wouldn't say how the problem should be solved. When inflation is back at the central bank's two per cent target, we will have to have a thorough review of how all our tools worked.
He admitted that they didn't get everything right. A lot of things are correct. There are some lessons to be learned.
Kevin Carmichael can be reached via email at kcarmichael@postmedia.
The email address is shughes@postmedia.