Crisis-era measures under fire as economy faces uncertainty
The Bank of Canada has emphasized the exceptional nature of tools like quantitative easing and extraordinary forward guidance, stating that their use should remain restricted to periods of significant economic distress. This assessment, part of a detailed review of its response to the COVID-19 pandemic, aims to guide the central bank’s strategy in future crises.
In March 2020, as the pandemic began disrupting global economies, the central bank slashed its key policy rate from 1.75% to 0.25% and introduced various liquidity measures and asset purchase programs. The review, released Friday, reflects on these decisions, balancing their successes against the risks they presented, including the potential for “moral hazard,” according to a Bloomberg report. The bank reiterated the need to maintain clarity about the conditions under which such measures might be deployed.
“The bank recognizes that these exceptional monetary policy tools should remain exceptional and be used only during periods of extreme economic stress,” the report stated.
Lessons from the pandemic
The central bank distinguished between two types of large-scale asset purchases it employed during the crisis: those aimed at stabilizing markets in the pandemic’s early days and those used later to stimulate the economy by lowering bond yields. Moving forward, the bank pledged to delineate more clearly between these approaches to ensure effective communication and policy implementation.
Studies cited in the review estimate that quantitative easing contributed between 0.2% and 3% to Canada’s GDP at its peak and added 0.1 to 1.8 percentage points to inflation. However, the bank acknowledged that these figures might not fully capture the impact of its measures.
Governor Tiff Macklem’s decision to signal prolonged low interest rates in 2020 was a controversial element of the bank’s strategy. While this guidance supported economic recovery, the review highlighted the risks of oversimplified communication, which could lead to public misinterpretation. To address this, the bank’s governing council agreed to tie forward guidance more explicitly to the inflation outlook in the future.
External challenges
The report comes as the bank faces mounting economic uncertainties. US president-elect Donald Trump has threatened 25% tariffs on Canadian imports, a move that could trigger a recession, Bloomberg noted. Prime Minister Justin Trudeau’s government has signaled plans for retaliatory tariffs. Meanwhile, Trudeau’s expected resignation and the political rise of Conservative Party leader Pierre Poilievre have added to the uncertain economic landscape. Poilievre has criticized the bank’s quantitative easing policies, blaming them for contributing to inflation.
Deputy Governor Toni Gravelle recently acknowledged that the evolving political and economic situation complicates the bank’s current policy response.
Broader implications
Economists Pablo Hernández de Cos, Kristin Forbes, and Trevor Tombe reviewed the bank’s report, describing it as “broadly positive” but raising questions about specific decisions. They noted the absence of discussion on why 0.25% was chosen as the effective lower bound for interest rates and whether deeper cuts could have mitigated the need for unconventional tools.
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