Bank of Canada: High Standards for Extraordinary Monetary Policy Measures

After a comprehensive assessment of their responses to the Covid-19 pandemic, the Bank of Canada has announced that extraordinary monetary policy tools such as quantitative easing and special forward guidance should only be deployed during periods of extreme economic stress. This announcement is part of a detailed report released on Friday. The analysis arrives at a time when U.S. President-designate Donald Trump is threatening tariffs that could potentially push Canada into a recession. The report highlights that the bank examined its experiences with large bond purchases during the pandemic and is aware of the so-called moral hazard. This hazard involves market participants taking greater risks in the expectation that the central bank will intervene in an emergency. To avoid this, the bank aims to establish clear guidelines on the specific situations in which such interventions will occur. The bank's findings also include distinguishing between purchases to support market stability and those aimed at reducing yields. During the pandemic, the latter became increasingly significant from July 2020. In future interventions, the differences are to be more precisely highlighted. The Bank of Canada stated that quantitative measures contributed between 0.2 and 3 percent to the gross domestic product. Simultaneously, the emergency bond purchases increased the inflation rate by 0.1 to 1.8 percentage points. However, the bank admitted that these estimates might not provide the complete picture. One of the most controversial decisions by Tiff Macklem, the bank's governor, in 2020 was to inform Canadians that interest rates would remain low longer than expected. The decision to use special forward guidance is now under criticism. In the future, it should be "conditional" and specifically linked to inflation prospects. Meanwhile, new uncertainties loom as Trump announced a 25% tariff on Canadian imports. The Canadian government under Prime Minister Justin Trudeau plans to increase taxes in response. This occurs in a politically turbulent environment: Trudeau wishes to resign while Pierre Poilievre is leading in the polls with the Conservative Party and has criticized the bank's handling of quantitative easing. A group of economists analyzed the bank's report and praised it overall but had concerns. They questioned why the bank regarded the 0.25% lower interest rate limit as effective and chose quantitative easing and forward guidance instead of further reducing interest rates.