Philip CrossBOC Governor Stephen Poloz seems to relish finding new ways to surprise markets and depress the Canadian dollar, writes Philip Cross.

By Philip Cross, April 24, 2018

Five years ago, then finance minister Jim Flaherty picked Stephen Poloz to be the Bank of Canada governor and replace the openly Liberal-leaning Mark Carney, who was leaving to head up the Bank of England. With just two years left in Poloz’s seven-year term, and the bank last week still refusing to depart entirely from its nearly decade-long low-interest-rate policy, it is time to begin taking stock of his tenure.

Overall, it is hard to come up with many positives, even discounting Poloz’s erratic communications style. Poloz has done more than stick with the post-crisis easy-money policies that Carney embraced. He seemed to relish finding new ways to surprise markets and depress the Canadian dollar. Canada to its credit did not join other central banks pursuing experimental new policies such as quantitative easing and negative interest rates, but Poloz stated a willingness to adopt them if necessary. If the saying about central bankers that “only hawks go to central bank heaven” is true, then none of the world’s current crop need be fitted for wings.

Poloz’s embrace of low interest rates, a weak dollar and a willingness to experiment with untested forms of stimulus contradicts the very core of how the conservative approach to monetary policy differs from liberals. The difference comes down to whether policies should be based on empiricism or evidence; empirical means based on all human experience (quantified or not), while evidence emphasizes the latest research data point. Liberalism makes a fetish of data going back only a few years or decades. Conservatism put its faith in principles that have survived the test of time going back generations and even millennia, especially those concerning human nature.

In monetary policy, the conservative view drawn from human experience emphasizes the risk of easy-money policies triggering asset-price bubbles and an excessive reliance on debt. Poloz has denied the existence of a housing bubble in Canada, while benignly watching economy-wide debt levels soar to record levels. These developments highlight the missed opportunity to normalize monetary policy once the immediate threat from the global financial crisis had passed in 2009, a tightening scenario endorsed by former bank governor David Dodge.

Instead of heeding time-tested warnings about the risks of excessive debt to economic and financial stability, Poloz conducted monetary policy based on questionable assumptions about the relationship between wages and the unemployment rate and the responsiveness of exports to a lower dollar. Low interest rates were supposed to stimulate demand, reduce unemployment and raise wages and prices, which has not happened in either Canada or other G7 nations. Meanwhile, the intended boost to exports from a devalued dollar never materialized. Poloz’s years as CEO of the Export Development Corporation from 2010 to 2013 likely played a role in his selection as governor, but he has no answers to why exports have not responded to the lower loonie. With exports sputtering and import costs rising, a lower dollar has held back Canada’s economy, reinforcing former Bank of Canada governor John Crow’s warning that it is a “bad idea to have a policy of promoting currency decline.”

Central banks were created to help mitigate the impact of recurring financial panics and bank runs. Financial stability, not low inflation, should be their primary goal; low inflation is just a tool to achieve that goal. In the run-up to the last global financial crisis, central banks became too fixated on low inflation at the expense of monitoring the stability of the financial system. Central banks, including the Bank of Canada, risk repeating the same mistake. This risk is heightened by what the Bank for International Settlements says is a fixation on the Consumer Price Index, a narrow measure of inflation that excludes the price of assets such as housing, stocks and bonds that have soared in recent years. A downturn in prices of some of these assets would destabilize the economy and the financial system.

Low interest rates were supposed to stimulate demand, lower unemployment and raise wages and prices, none of which have happened

The conservative approach prefers to base monetary policy on rules rather than discretionary judgment. Rules are based on centuries of human experience, not the fallible judgement exercised by a select few of today’s experts. Examples of rules-based monetary policy include strict monetary-growth targets (Milton Friedman wanted to replace the Federal Reserve Board with a computer programmed to generate steady money growth), fixed exchange-rate regimes, or formulas such as the “Taylor Rule” that mechanically link interest rates to inflation and the underlying slack in the economy. A side benefit of rules is that they would discourage the cult of the central banker as rock star, which began with Alan Greenspan and reached its apex in Canada with Carney.

It appears the decade-long experiment of maximum discretionary monetary policy in the G7 is ending, with at best a poor record of supporting short-term growth at an unknown long-term cost of inflation and financial instability. Canada has long given Bank of Canada governors unusual discretion to use whatever tools they deem necessary to achieve low inflation and growth. A decade of central-bank experimentation has failed to ignite growth but has increased financial risks, notably in the pension system. If either the economy or our financial system suffer a significant setback, Poloz’s legacy ironically might be facilitating a return to a more conservative monetary-policy regime, one that upholds the old motto that “rules rule.”

Philip Cross is a Munk senior fellow at the Macdonald-Laurier Institute.