Ambler, Kronick - Why Canadian Quantitative Easing Needs Transparency

Importantly, there is currently a question that certainly needs to be considered and not neglected, which is, why does Canadian quantitative easing need transparency?

And it is that, for the first time in its history, with the night rate reaching its effective lower limit of 0.25 percent, the Bank of Canada has embarked on the path of quantitative easing (QE). This clearly implies the direct purchase of financial assets by the bank, which reduces its returns. QE was used by the Federal Reserve Bank and other central banks during the financial crisis, although the Bank of Canada avoided having to use it.

Despite this, currently, with less room to reduce the interest rate overnight, the Bank was forced to quickly resort to unconventional monetary policy. Transparency on what assets will be purchased and on the Bank’s strategy to control inflation will be essential for the success of this operation.

Implications for the bank’s balance sheet in addition to inflation

Indeed, if the Bank makes direct purchases of commercial paper only from banks and other institutions that maintain settlement balances at the Bank, this would be consistent with the Bank’s traditional role as a lender of last resort financial institutions.

Without a doubt, the Bank must be as explicit as possible about the counterparties to these transactions and the criteria for determining which assets it will buy and acquire. Specific ground rules must be communicated through an explicit agreement with the Government of Canada. QE will also have significant monetary consequences that are not yet completely clear. What is clear is that the monetary base and / or the broader monetary aggregates will increase dramatically. With a minimum of $ 5 billion per week of purchases of Canadian Government securities, the Bank’s balance would double in approximately 6 months.

Thus, when the economy finally recovers, the expansion of monetary aggregates will eventually become inflationary as more money encourages more spending. The pressure on inflation will depend on how quickly the supply can respond to the accumulated demand. The supply response, in turn, will depend on whether supply chains can remain intact, depending in part on how other countries are dealing with the effects of COVID-19.

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Source: Ambler, Kronick | C.D. Howe Institute