April 23, 2020 – Between early March and mid-April, the Bank of Canada’s balance sheet more than doubled, dwarfing anything seen in 2008. Moreover unlike 2008, this increase has serious implications for future inflation, because the Bank’s increased liabilities are not the result of government deposits, but rather increased “settlement balances” or deposits by financial institutions, which increases the monetary base.
Once the pandemic and economic crisis passes there is no easy solution to the potential inflation problem arising from more money chasing fewer goods and services. Trying to unwind the Bank’s balance sheet by selling longer-term assets is fraught with political risk. Alternatively, while a floor system could help manage excess inflationary pressures, this approach has a clear trade-off, specifically, it could lead to lower levels of commercial bank lending. The Bank could navigate its balance sheet position by:
- Buying debt at the shortest-term possible to allow as much roll-off as possible.
- Ensuring some form of federal government guarantee or backstop on non-sovereign and private sector debt to minimize credit risk.
- Setting a target for the intervention for a particular asset-class based on the estimated size of the market disruption, starting small to see the impact from the Bank’s mere presence in that market.
- Being transparent about the criteria on what assets to buy, on any third party or parties used to buy these assets.
- Operating under an explicit agreement with the federal government to minimize politicization.
- Being transparent on exit strategy, and if considering the longer-term use of a floor system, being upfront.
For more information, please contact: Jeremy Kronick, Associate Director, Research, C.D. Howe Institute; Laura Bouchard, Communications Manager, C.D. Howe Institute: Phone: 416-865-9935; email: lbouchard@cdhowe.org