Category: Canada

Banking, Canada, Finance, Inflation

Why we can’t just ‘stop printing money’ to get inflation down

Jacqueline Best
https://images.theconversation.com/files/457998/original/file-20220413-26-h1sbqm.JPG?ixlib=rb-1.1.0&rect=0%2C343%2C6352%2C3176&q=45&auto=format&w=1356&h=668&fit=crop

With the Bank of Canada announcing an oversized interest rate hike this week, it might seem like central banks are coming to rescue us from inflation once again. Yet while they did play an important role in mitigating a COVID-induced recession, central banks don’t have the power to solve our inflation problem.

There’s no question that the inflation outlook today is worrying. With inflation hitting 5.7 per cent in March, we are facing a perfect storm of inflationary pressures from a combination of supply chain bottlenecks, pent-up demand and massive increases in energy prices from Russian sanctions.

As politicians start to make noise about inflation, we need to be careful not to accept the outdated assumption that central banks can control inflation by limiting the money supply.

Conservative Party leadership hopeful Pierre Poilievre recently asserted that the solution to inflation is to “stop the central bank from printing money to pay for government spending.” This is not only factually incorrect (the Bank of Canada stopped purchasing large amounts of government bonds back in October of last year), but also outdated.

The legacy of monetarism

Back in the late 1970s and early 1980s, Ronald Reagan and Margaret Thatcher capitalized on public anxiety around rising prices by bringing their conservative governments into power on the promise of getting tough on inflation using monetarism.

We should not be too surprised, then, to see the legacy of this outdated economic policy living on in members of the Conservative Party of Canada.

Poilievre has resurrected the age-old theory — let’s call it quack monetarism — that inflation is caused by too much money circulating in the economy and that the solution is to reduce the central bank’s money creation. Inflation has never only been about money; central banks can’t just wave a magic wand and get it down again.

The limits of monetary policy

While central banks do play an important part in getting inflation under control by setting interest rates, they don’t have all the tools needed to get inflation down this time around — particularly when some of the dynamics driving price increases will not respond to changes in interest rates.

As writer Adam Tooze points out, monetary policy can’t improve bottlenecks in the supply of microchips — which are driving car prices higher — or increase the supply of gas.

Even when monetary policy is effective in getting inflation down, there is always the risk of the central bank overshooting its aims and pushing the economy into a recession — as a growing number of policymakers worry may happen today.

Quack monetarism

So why do conservative politicians like Poilievre want us to believe we can solve this problem by getting the central bank to stop printing money? This is the kind of “zombie idea” that won’t die, in spite of being proven wrong, because its simplicity is so politically appealing.

This claim harks back to Milton Friedman’s famous dictum that inflation is “always and everywhere a monetary phenomenon.” The monetarist theory that Friedman advocated and which became very influential in the 1970s and early 1980s assumed the solution to inflation was to limit the expansion of the money supply.

What’s wrong with this idea? American banker Henry Wallich famously responded to Friedman’s statement by replying, “inflation is a monetary phenomenon in the same way that shooting someone is a ballistic phenomenon.” In other words, an excess of money may be partly to blame for inflation, but if you want to truly solve it, you need to understand the underlying causes of the problem.

As political economist Matthew Watson has shown, economists keep changing their minds about the broader causes of inflation: shifting from pointing a finger at international balance of payments shocks in the 1960s to the oil crisis in the 1970s, the “wage-push” inflation in the 1980s, governments’ lack of anti-inflation credibility in the 1990s and finally the problem of unanchored inflation expectations in the past few decades.

Even if today’s inflation had similar causes to the 1970s, we don’t want to try monetarism again. Central banks in Canada, the United States and the United Kingdom all tried it in the late 1970s. By 1982 they had given up on it because monetarism simply did not work.

Most money is actually created by private banks and so attempts by the central bank to limit the money supply are doomed to failure. The bank can influence the demand for money by increasing or decreasing interest rates, but does not control the money supply itself.

Monetary policy is a blunt instrument

What finally did get inflation down in the 1980s was a combination of punishingly high interest rates — over 21 per cent in Canada — and the most painful recession since the Great Depression, with unemployment rising to 12.8 per cent in Canada. This is not an experience that we want to repeat.

If the economic trauma of 1970s and 1980s teaches us anything, it’s that monetary policy can be a very blunt instrument. To be truly effective, it must often be brutal.

While there are no simple solutions to our current inflationary challenges, it’s clear we need a holistic approach. U.S. President Biden’s recent strategy provides one promising alternative. His goal is to tackle inflation by pressing companies to reduce costs, rather than wages, and by making prescription drugs, energy and childcare more affordable.

So the next time a politician tries to sell you on a quack monetarist remedy for our current inflationary woes, ask them if they’re willing to make us all pay the costs of another historic economic blunder.

This blog was first published on The Conversation on April 13, 2022.

Canada, Economics, Inequality, Political economy

Bidenomics signals the end of the Third Way in economic policy

Jacqueline Best

Biden’s first 100 days clearly signals the end of the Third Way in economic and social policy. With massive investments proposed in social infrastructure and education, a willingness to take a positive sum approach to budget deficits, and a commitment to fund those investments partly through higher corporate taxes it’s clear that the Third Way is now truly dead.

For those who may not remember (or who have been all too happy to forget) the Third Way was a strategy cooked up by Centre-left parties in the 1990s who hoped to ride the coattails of a highly deregulated economy and booming stock market while also mitigating some of its damage through targeted social spending. It was called the “Third Way” because it sought to distance itself equally from conservatives and from social democrats. This was the policy style that defined Clinton’s “triangulation,” Tony Blair’s “New Labour,” and Jean Chrétien’s deficit-busting mantra.

The cost of these policy failures has become obvious in recent years, as we have witnessed the 2008 global financial crisis, growing inequality, and the rise of populist resentment—not to mention the discovery that cuts to the public health infrastructure may have trimmed a few government budgets over the year but at the cost of thousands upon thousands of lives (and a shuttered economy) today.

Although Joe Biden was a card-carrying member of the Third Way club in his earlier days, given the huge costs of these mistakes, it is little wonder that he has recognized that it is time for a different approach to the economy.

There are at least three key ways in which Biden’s economic policy breaks with the logic of the Third Way, each of which has important implications for Canadian economic policy.

First, Biden has proposed a massive increase in social spending. His Families Plan aims to invest $1.8 trillion over 10 years and includes support for free universal preschool, paid family and parental leave, investment in child care and education. As Adam Tooze has pointed out recently, the theme of investing in families is in fact central to all three of Biden’s major spending initiatives: the $1.9 trillion Rescue Plan, which has already been signed into law, included a significant, but temporary, family allowance system, while the $2.3 trillion Infrastructure and Jobs Plan includes major investments in elder care.

In a few short months, Biden has upended decades of doomed neoliberal efforts to economize on government spending by cutting social spending and offloading on women the cost of what feminist political economists call “social reproduction”—the work of raising children, keeping households going, and caring for the old and the ill—which the formal economy depends on to keep going.

Although women’s double burden helped families to eke out more from stagnant wages, it seriously affected women’s capacity to participate fully in the formal labour market. As Biden, Justin Trudeau and others from the Centre-left have finally recognized, the savings that deficit-busting governments gained from not investing in women and children was therefore always a false economy. As Quebec has made clear, affordable daycare more than pays for itself with the extra tax receipts earned when women are fully active in the workforce.

Second, Biden has finally given up on the Third Way faith in the virtues of balancing budgets and reducing debt. It was always particularly painful to watch Clinton and Obama Democrats, Chrétien Liberals and Blair’s Labour Party cut and cut and cut away all of the programs that they had once helped to create in the belief that this was the only way to get government back on solid fiscal ground. (Of course, Republicans from Reagan onward never believed in balancing their budgets, even as preached the virtues of the “Washington Consensus” on those in the Global South.)

It seems that Biden and his Treasury Secretary, Janet Yellen, like Trudeau and our Finance Minister, Chrystia Freeland, have finally recognized that the zero-sum logic of balanced budgets as an end in themselves is based on a fundamental fallacy. If a country cuts back too much on its spending in the name of austerity, it can create a downward spiral of less consumption, lower investment and increased unemployment, actually slowing the recovery (as we saw in Greece and the UK after the 2008 crisis). On the other hand, the build-up of careful, productively-invested debt can generate decades of growth that not only make a country wealthier but also ensure that the wealth benefits more of its population.

Finally, Biden has proposed that some of the additional spending should be paid for through higher taxes on the wealthy and on corporations. He seeks to double the tax on capital gains and raise corporate tax rates from 21% to 28%. This is a crucial shift after decades in which the Centre-left has gone along with the neoliberal myth that helping out investors and big corporations ultimately trickles down to the rest of us, while raising their taxes only hurts consumers. In fact, as the Tax Policy Centre notes, most corporate taxes in the US are paid for by investors—with 70% paid by the top 5% of income earners.

This is the one area where Biden is clearly ahead of the Trudeau Liberals in challenging the myths of the Third Way. There has been no sign of the current Canadian government wanting to reverse the Chrétien Liberals’ sharp reduction in the capital gains tax or to raise corporate taxes (which were also slashed under Chrétien, and then further cut by Harper). It appears that the Trudeau Liberals are not ready to discard their unhealthy relationship with big business and challenge the Third Way myth of corporate trickle-down.  

Although it’s hard to say how much of this ambitious plan Biden will get through Congress, what is clear is that by challenging the damaging myths of the Third Way, Biden has shown that it is possible to imagine a more just economy, not just in the US but around the world.

This blog was originally published on the CIPS Blog, May 31, 2021.

Banking, Canada, Economics, Finance

The Bank of Canada must seize the pandemic’s historic moment and embrace innovation

Jacqueline Best

Peter Dietsch & Jacqueline Best

The Bank of Canada, like central banks around the world, is currently facing enormous upheaval and uncertainty due to the enduring COVID-19 pandemic.

Will its leadership seize the moment as an opportunity to innovate and respond to the challenges ahead, including rising inequality and climate change? Or will it treat the present crisis as a temporary exception, hoping to return to business as usual once the pandemic recedes?

This spring, the bank released the results of its consultations with Canadians as part of its current mandate review. This is a historic opportunity for our central bank and the federal government to make the bank work better for the Canadian people.

As academics specializing respectively in philosophy and economics, and politics, we’d like to highlight two key themes that emerged in the Bank of Canada’s consultations with Canadians.

Wealth inequality, climate action

First, many Canadians are deeply concerned about the increasingly unequal distribution of wealth in this country — particularly by the way it has been driven by skyrocketing house prices. Second, some Canadians would like to see the Bank of Canada take the threat of climate change seriously as it plays its key role in ensuring price and financial stability.

How could the bank do better in tackling these two core problems — the scourge of rising inequality and the future shocks of climate change?

On inequality, there are many useful models around the world. Although Canadians like to think that we’re more progressive than our neighbour to the south, the United States is actually well ahead in rethinking the role of their central bank. Its recent shift towards what’s known as average inflation targeting, a strategy that seeks to balance inflation and growth over the medium term, gives it more flexibility to promote employment.

Such a strategy, potentially combined with a dual mandate of price stability and employment, would allow the Bank of Canada to pay more attention to the needs of all Canadians. The bank’s consultations with Canadians suggest that there is in fact considerable support for such a move.

While this would be a first and important step in modernizing the central bank’s mandate, we need to go further and take a more careful look at some of the unconventional policy tools that the central bank has been using in the last year.

Quantitative easing

Since the COVID-19 crisis took hold, the Bank of Canada joined other central banks in engaging in what’s called quantitative easing, initiating massive purchases of financial assets. As a result, its balance sheet has increased by close to 500 per cent since March 2020.

Such liquidity injections by central banks are clearly necessary. The question is how this liquidity should be injected.

Suppose your doctor prescribes you a drug that is known to have serious side effects. Wouldn’t you want her to look into alternative treatments? The experience with quantitative easing since 2008 shows that it has two serious side effects, both of which speak to some of the core concerns of Canadians.

First, it exacerbates inequality. While the central bank may want to see a good portion of the injected liquidity used to stimulate real economic activity, this is not something it can control. Instead, a lot of the liquidity has ended up in stock markets and housing markets, benefiting wealthy asset owners and helping to push the cost of owning a house beyond the means of many Canadians.

As Mark Carney, then governor of the Bank of England, acknowledged in 2014, “the distributional consequences of the response to the financial crisis have been significant.” The same is true today.

Second, when quantitative easing includes buying corporate bonds, it facilitates access to capital markets for the firms in question. Central banks appeal to the idea of “market neutrality” and claim that an asset purchase that reflects current bond volumes on capital markets does not favour anyone in particular. But in countries like Canada, when you buy a basket of corporate bonds proportional to the outstanding bonds on the market, you inevitably reinforce the status quo with its many companies that have large carbon footprints. That inevitably slows the transition to a more sustainable economy.

Politics comes with the territory

Some will caution that independent central banks should not get involved with such deeply political issues. The answer to this is simply: It’s too late for that. Political decisions come with the territory of central banking today, and we better develop innovative policy instruments to reflect this reality.

Other central banks are adapting already. In December, the Swiss National Bank announced that its asset purchases will exclude all companies primarily active in coal mining.

Perhaps more significantly, since Christine Lagarde has taken over as president of the European Central Bank, the institution has vowed to take a more active stance on climate change.

Unconventional policies can also be used to alleviate — instead of exacerbating — inequality. One idea is to transfer money to citizens through so-called helicopter money, rather than rely on institutional investors to translate quantitative easing measures into economic stimulus. The policy response to COVID-19 actually provides an interesting blueprint for this.

The overall tone of the Bank of Canada’s consultations report seems to suggest that the bank is more comfortable with the status quo than with serious innovation. Although this may sound very Canadian, our central bank actually has a history of being an innovator in monetary policy. It was among the first central banks to adopt monetarism in 1975, and the second to adopt inflation targeting in 1991 when it was still an untested approach. To confront today’s many challenges, the Bank of Canada needs to rediscover that innovative zeal.

This blog was originally published on The Conversation, May 4, 2021.

Banking, Canada, COVID-19

Can the Bank of Canada come to the rescue again?

Jacqueline Best
Bank of Canada headquarters.
Bank of Canada headquarters – from globalnews.ca

Like central banks around the world, the Bank of Canada has cut its target interest rate in order to tackle the economic effects of the novel coronavirus.

Does that mean that central bankers are once again our knights in shining armor coming to save the day in an economic crunch? Or is this finally the right time to recognize that we can’t keep counting on the Bank of Canada to do all of the economic heavy lifting in a crisis?

This rate cut does signal the central bank’s willingness to do what it can to counteract the economic consequences of the virus’s spread. Yet there is only so much that lower rates can do. They can make it easier for people and businesses to borrow and they will reduce payments on a flexible rate mortgage. But low rates won’t help companies continue to make the products that rely on parts made in hard-hit countries like China and South Korea, and they won’t help people afford to take time off of work if they get sick.

While it isn’t yet clear yet how serious the economic effects of the virus will be, this is a good time to take stock of what tools we have to respond to the next economic crisis.

Ever since 2008 financial crisis, the Canadian government, like governments around the world, has relied an awful lot on the super-powers of the central bank. G7 politicians decided that they didn’t want to have to keep using fiscal policy to stimulate the economy and started treating central banks like “The Only Game in Town,” as former Bank of England Deputy-Governor, Paul Tucker, put it.

Yet the last decade has made it clear that there are very real drawbacks to assuming that central banks can always save the day.

The Bank of Canada has had to keep interest rates very low for a very long time to keep the economy going. While this has worked, to a point, it has had perverse consequences. Canadians took advantage of the low interest rates to go on a spending spree—building up debts worth as much as 177% of their annual income. This borrowing binge and the housing bubble that has gone with it has limited the Bank of Canada’s options moving forwards: by cutting rates, they run the risk of pushing debt even higher, but by increasing rates they could precipitate a crisis for the many families who can barely make their interest payments.

Given these limits, one option for the Bank of Canada would be to pursue unconventional monetary policy. In doing so it would be following the lead of the US, Japanese, British and European central banks that have dabbled in more esoteric monetary policies after the 2008 crisis, including “quantitative easing,” which has central banks creating new money to buy up government and private sector bonds and securities.

While these unconventional tools may be useful and even necessary, they do produce winners and losers. Top-down strategies like quantitative easing have actively contributed to growing inequality (by increasing the value assets that are mostly held by the wealthy), and has accelerated the climate crisis by disproportionately investing in carbon-intensive firms. On the other hand, bottom-up strategies, like “helicopter money,” where the central bank distributes new money to individuals, have been overlooked to date.

Politicians had hoped in the last crisis that they could avoid making difficult political decisions by passing the buck to central bankers who are insulated from the democratic process. Unfortunately, this past decade has taught us that there is no such thing as an apolitical solution to an economic crisis. Whatever role the Bank of Canada plays, it needs to be guided by democratic—and not just technocratic—priorities.

We do need central banks to play their part now—and we will need them again in the future. But we also need to make sure political leaders stop waiting for their knight in shining armor to come to the rescue and take responsibility for their own role in responding to economic shocks.

This blog post was original published as an opinion piece in the Ottawa Citizen on March 11.

Accountability, Canada, Inequality, Political economy

Scrooge in Paradise: Why Private Wealth is a Public Issue

Jacqueline Best

Scrooge

As global inequality grows to “extreme levels” — as revealed in the just-released World Inequality Report — it is hard not to wonder what it bodes for the health of liberal democracy — around the world and here in Canada.

Even though our growing levels of inequality may not come close to those in the United States, recent conflict-of-interest stories about both Liberal and Conservative MPs, a growing reliance on tax havens, and cash for access scandals all raise serious concerns about the influence of the wealthy in Canadian politics.

If money talks, then the rich are now deafening the democratic system. As economist Branko Milanovic explains, “the higher the inequality, the more likely we are to move away from democracy toward plutocracy.”

One of my favourite recent New Yorker cartoons shows two men in business suits looking out from a lavish corner office, as one says to the other, “Part of me is going to miss liberal democracy.”

Although we’re not quite there yet, the dark tone of the cartoon reminds us that the economic “haves” can be just as likely to become disaffected with democratic politics as the “have-nots” often singled out as the source of populist pressures (in fact, elites have historically been the most important factor behind de-democratization, as Charles Tilly notes in a recent book).

Reading that New Yorker cartoon, it is hard not to imagine that at least one of those businessmen is likely to be a good friend of President Trump’s. He’s turning conflict of interest into performance art, talking up his daughter’s clothing line and getting national park gift shops to sell Trump branded wine.

Yet, while Trump and entourage demonstrate a particularly brazen willingness to blur the line between public office and private gain, the problem is a much wider one — with echoes here in Canada.

The Paradise papers revelations, the cash for access scandals, and the use of “loopholes” in ethics screens are all legal strategies for giving the wealthy an unfair advantage in a system where we are all supposed to be equal as citizens. Each of these strategies works in a different way to undermine the democratic culture that makes our political system work. In the process, they further blur the line between public good and private gain, eroding the trust that makes democratic politics viable.

Cash for access is the most straightforward. It takes the existing informal advantage that the wealthy have to ensure that their voice is heard politically and weaponizes it. Why bother voting as an ordinary Canadian when politicians will spend their time listening to someone paying $10,000 for a rubber chicken dinner?

The “loopholes” in ethics screens that various Liberal cabinet ministers have admitted to using, as well as the failure of certain Conservative MPs to disclose business ties to China, work more subtly. They create the possibility that public office holders will be swayed by their private assets as they make decisions designed to serve the public good. Why bother being an engaged citizen when you don’t know whether those making the decisions are pursuing their own interests or ours?

The Paradise papers tell us that many of the public figures who speak and act in the name of the public good use tax havens to avoid paying their fair share. Why bother buying into a democratic system requiring that we all do our part by paying taxes when those with the most power are actively avoiding doing so?

Of course, the line that we draw between public and private in a liberal democracy is always something of a fiction. Liberal political thought tells us that everyone is an equal citizen in the public domain, with an equal right to participate politically. Liberalism is also based on the premise that we should be free to pursue wealth accumulation in our private lives, meaning that we will often be quite unequal in economic terms.

In theory, this private inequality should not affect our formal public equality as voting citizens. In practice, things are rather different, as wealth often translates into a greater political voice — as any government that has tried to put a halfway house into an affluent neighbourhood or to reduce tax advantages for doctors incorporated as small businesses will tell you.

To keep a democracy alive, and to ensure that everyone has a meaningful voice and stake in the political system, we must do two things. We must work to keep those private inequalities from getting too large (via public education, social programs, a progressive tax system, etc.). And we must work to minimize the ways in which private inequalities translate into unequal influence (via election financing laws, conflict of interest provisions, etc.).

In Canada, we have made progress on some of these measures, but we have also fallen behind in many respects. As recent census data shows, earnings inequality has continued to grow in Canada over the last decade, while the top 1% increased their share of total income in 2015.

When trying to figure out how we got here, there is blame enough to go around. The Chrétien Liberals began the trend towards growing inequality when they gutted transfer payments for social programs in the 1990s. Inequality grew under the Harper Conservatives, who also eroded some of the other bulwarks against buying political influence, notably through reversing changes to election financing laws, making parties more reliant on private donors once again.

Although the Trudeau Liberals have clearly stated their desire to reduce inequality, and have begun to tackle some of these problems, their own recent conflict of interest scandals suggest a very long way to go before the political culture in Ottawa starts to change.

As that New Yorker cartoon reminds us, unless we start taking the problem of inequality much more seriously now, we may soon find ourselves thinking nostalgically of the “good old days” of liberal democracy.

This blog post originally appeared on the CIPS Blog on December 19, 2017.

Canada, Economics, Inequality, Political economy, Theory

Rebuilding the middle class: The Liberals have a chance to rectify their past economic mistakes

Jacqueline Best

As the new Liberal government starts to put its economic plan into action, its commitment to paying attention to the evidence (unlike its Conservative predecessors) should provide them with both comforting and cautionary tales.

On the one hand, there is ample evidence to support the Trudeau government’s plan to allow for short-term deficits in order to reinvest in infrastructure and rebuild the middle class. On the other, the data also points to a rather more inconvenient truth: the trend towards growing inequality actually started on the Chrétien Liberal government’s watch.

A recent report by TD Economics notes that while the top 20% of income earners have gained 30% since 1976 (most of that since 1994), the middle 20% have only seen an increase of about 5% in that time. More tellingly, the report suggests that it was only in the mid-to-late 1990s that the level of inequality in Canada began to take off “when governments stopped leaning against income inequality.”

During the campaign, Justin Trudeau demonstrated his willingness to take on board new economic thinking and break with the old Liberal Party’s obsession with paying down the debt at any cost. Although the Trudeau Liberals’ willingness to run a small fiscal deficit in the short-term was ridiculed by the Conservatives and challenged by the NDP during the election campaign, it is actually entirely consistent with much mainstream economic policy thinking today.

A recent discussion note by economists at the International Monetary Fund (not exactly known as a bastion of left-wing thinking) warned governments like Canada against imposing austerity measures in order to pay down their debts more quickly. The authors note: “While debt may be bad for growth, it does not follow that it should be paid down as quickly as possible.” In fact, “If fiscal space remains ample, policies to deliberately pay down debt are normally undesirable.”

Or, to borrow former NDP leader, Jack Layton’s, well-known phrase (as noted in a column by Andrew Coyne last March) there is little point in paying down your mortgage faster when your house is falling down from badly-needed repairs.

This reminder of Layton’s common-sense wisdom should tell us two things. First, and most obviously, the NDP lost its way in its efforts to seem economically credible enough to govern. While there is no question that the party had far less political leeway than the Liberals to challenge what has become a Canadian obsession with balanced budgets and debt-reduction, by setting aside the more hopeful ambitions of Layton’s NDP, Mulcair and his advisors ended up in the odd position of being more conservative than the IMF (not to mention Andrew Coyne).

Second, we need to remember that it was the Chrétien and Martin Liberals, not the Conservatives, who made debt reduction a centrepiece of their economic policy in the 1990s and early 2000s.

The first cuts made in the 1990s were designed to reduce what had become a genuinely unsustainable deficit. Back then, Canada faced a milder version of Greece’s recent dilemma, with bond markets increasingly suspicious of the government’s credit-worthiness.

Yet what started as a strategic response to external pressures soon became an end in itself: the running of surpluses to pay down the debt became a mantra—part of the brand of the Liberal Party itself.

As we now know, that policy had its own very serious human costs.

I remember well the moment when the Liberal government stopped leaning against inequality and started to dismantle the same social policies that Pierre Trudeau’s government had built. I was a parliamentary intern in the House of Commons from the Fall of 1994 to the Spring of 1995 (in fact, one of my fellow interns was Arif Virani, who has just been elected as a Liberal MP for Parkdale-High Park). I watched a Liberal party that had campaigned on the left move sharply right. I watched smart, progressive politicians like Lloyd Axworthy overseeing the erosion of our social infrastructure, and I tried to understand why.

That experience shaped the rest of my career. I decided to go back to university and become a professor of international political economy in order to try to understand why countries like Canada could believe that they had to destroy their social fabric in order to survive economically—and how we could prevent this happening again.

In the twenty-plus years since I first sought to understand how Canadians can foster a caring and just society in a competitive and often unstable global economy, I have not come up with any easy answers.

But I do know that a Liberal government that is genuinely open to learning from the evidence, and committed to paying attention to inconvenient truths, will not reproduce the same mistakes that it once made.

Rising inequality hurts all of us. Recent research has shown that more unequal societies don’t grow as quickly, as many members of society find themselves unable to invest in their education and training, decreasingly overall productivity.

As the TD Economics report notes, the factors that allowed us to avoid the more radical hollowing out of the middle class seen the United States in recent years can no longer be counted on, as the commodity boom comes to an end and the hot housing market starts looking increasingly like a bubble about to burst (or at best deflate). Without creative government action, we are at risk of falling into a vicious cycle of lower growth, cuts to programs, further inequality and even lower growth.

While some might argue that the Bank of Canada’s recent downgrades to the economic outlook should push the Liberals back into their old austerity mode, that zero-sum game no longer holds water. As middle-class jobs come under even more pressure, leaning against inequality can help us all.

This was originally posted on the CIPS Blog.

Banking, Canada, Finance, International development, Risk, Uncertainty

Canada needs to do a better job of managing financial uncertainty

Jacqueline Best

Published in the Hill Times, May 25, 2015

As Canadians, we pride ourselves on how well our financial regulations coped with the 2008 financial crisis. Given this attitude, it’s not surprising that Canadian policymakers have avoided a major overhaul to our regulations in response.

Yet we need to make sure that this pride in our system does not lead to complacency. Rather than just looking backwards to how the Canadian financial system performed in the last crisis, we also need to look forwards and recognize how much the global economy is changing.

Those changes take two key forms. First, the economy has become much more uncertain since the crisis. And second, a number of other countries have raised the bar for financial regulation. If Canadians don’t catch up with these two major shifts, we may well find ourselves in trouble.

Whether we look at the International Monetary Fund’s latest Global Financial Stability Report, or the Bank of Canada’s recent Financial System Review, it is clear that both the global and national economies have become increasingly uncertain. That uncertainty defines some of the most important aspects of our economy, whether we look at the likely medium-term impact of the decline in oil prices, the potential for a hard landing in an overheated housing market, or the possibility that Canadians will wake up one day and realize that their household debt level is unsustainable.

This environment of profound uncertainty poses serious policy challenges.

In the good old days of the so-called “Great Moderation” from the mid-1980s to the financial crisis, policymakers were able to focus on what Donald Rumsfeld famously described as “known unknowns”—the kinds of risks to which policymakers could assign definite probabilities. Today, we are faced instead with a great deal of “unknown unknowns”—the kinds of uncertainty that resists formal modeling, as Bank of Canada Governor, Stephen Poloz noted in a recent paper.

How should we regulate financial markets in the face of this kind of uncertainty? Very carefully. As it becomes increasingly difficult to predict what kinds of complex risks the economy might face, we need to err on the side of caution.

As good Canadians we might assume that we already have some of the most cautious financial regulations around. Yet this is no longer the case.

Yes, Canada has implemented the capital adequacy standards set out in the Basel III accord very quickly. Yet our government has treated those requirements as the gold standard, when they were designed to be a bare minimum. On the other hand, the United Kingdom and the United States are in the process of implementing more demanding standards, including adopting higher and stricter leverage ratios. While Canada was one of the only countries with a leverage ratio requirement before the crisis, we now starting to look relatively lax.

Even more striking is the fact that Canada, unlike every other major country, has no central body responsible for coordinating efforts to manage systemic risk. The Canadian regulatory universe is fragmented, with important pieces of the regulatory puzzle managed by half a dozen agencies plus a multitude of provincial authorities. The Bank of Canada does an admirable job of identifying potential sources of systemic risk, but they have few tools for acting on them.

Canadian authorities have engaged in macroprudential regulation in recent years—most notably through their efforts to cool the housing market down. Yet, as a recent IMF report points out, those efforts have unintentionally encouraged those who no longer qualify for prime mortgages into the under-regulated world of “shadow lending,” potentially increasing systemic risk. In order to manage an uncertain economy, someone needs to be able to look at the system as a whole: to connect the dots that link regulations governing consumer credit, mortgages, interest rates, big, small and “shadow” banking institutions.

What about the usual financial sector response that more regulation will cost Canadian financial institutions, and thus the economy, more generally? We should have learned by now that the cost of another crisis would be much greater still. Given the triple threat of uncertain oil prices, a volatile housing market and rising consumer debt, another crisis would likely hit us harder than the last one. It’s worth being well prepared for that kind of risk.

Posted on the CIPS Blog June 5, 2015. 

Canada, Failure, International development, Measurement, Risk, Theory

What counts as policy failure — and why it matters

Jacqueline Best

When things go wrong in politics, the word ‘failure’ gets bandied around a lot. In recent weeks, we’ve heard about the failure of Canadian drug policy (as admitted by Stephen Harper), the failure of Canadian diplomatic efforts to get Barack Obama on board for the Keystone XL Pipeline (as declared by his critics), and the failure of European leaders and the ‘troika’ to find a long term solution to the problems posed by the Greek economy (as acknowledged by most sensible commentators).

These declarations of failure, of course, are not uncontested. In each case, there are those who would challenge the label of failure altogether, and others who would lay the responsibility for failure on different shoulders. Labeling something a failure is a political act: it involves not just identifying something as a problem, but also suggesting that someone in particular has failed. These debates about failures are crucial ways in which we assess responsibility for the things that go wrong in political and economic policy.

The most interesting debates about policy failure, however, occur when what’s at stake is what counts as failure itself.

When we say that something or someone, has failed, we are using a particular metric of success and failure. Formal exams provide the clearest example of assessment according to a scale of passing and failing grades. In most cases, such metrics are taken for granted. (Even if some students might not agree that my grading scale is fair, I am generally very confident when I fail a student.) But sometimes, if a failure is serious enough, or if failures are repeated over and over, those metrics themselves come into question. (I did once bump all the exam grades up by five percent in a course because they were so out of line with the students’ overall performance.)

In politics, these contested failures force both policymakers and the wider community to re-examine not just the policy problems themselves but also the measures that they use to evaluate and interpret them. These moments of debate are very important. They are very technical, focusing on the nuts and bolts of evaluation and assessment. Yet they are also fundamental, since they force us to ask both what we want success to look like and to what extent we can really know when we’ve found it.

In my recent book, Governing Failure, I trace the central role of this kind of contested failure in one particular area: the governance of international development policy. Policy failures such as the persistence of poverty in Sub-Saharan Africa, the Asian financial crisis and the AIDS crisis raised very serious questions about the effectiveness of the ‘Washington Consensus’, and ultimately led aid organizations ranging from the International Monetary Fund and the World Bank to the (then) Canadian International Development Agency to question and reassess their policies.

The ‘aid effectiveness’ debates of 1990s and 2000s emerged out of these contested failures, as key policymakers and critics questioned past definitions of success and failure and sought to develop a new understanding of what makes aid work or fail. In the process, they shifted away from a narrowly economic conception of success and failure towards one that saw institutional and other broader political reforms as crucial to program success.

International development is not the only area in which we have seen a significant set of failures precipitate this kind of debate about the meaning of success and failure itself. The 2008 financial crisis was also seen by many as a spectacular failure. The crisis produced wide-ranging debates not just about who was to blame, but also about how it was possible for domestic and international policymakers and market actors to get things so wrong that they were predicting continued success even as the global economy was headed towards massive failure.

In the aftermath of that crisis, there was a striking amount of public interest in the basic metrics underpinning the financial system. People started asking just how risks were evaluated and managed and how credit rating agencies arrived at the ratings that had proven to be so misleading. In short, they wanted to understand how the system measured success and failure. Many of the most promising efforts to respond to the crisis—such as attempts to measure and manage systemic risk—are also aimed at developing better ways of evaluating what’s is and isn’t working in the global economy, defining success in more complex ways.

Of course, not every failure is a contested one. Many have argued that the reasons for the failure of Canadian drug policy are less contested than Harper has suggested. Critics note that the Conservative government’s unwillingness to take on board the lessons of innovative policies such as safe injection sites goes a long way towards explaining this policy failure.

On the other hand, some failures—such as the failure not just of Greece but also of much of Europe to restart their economies—should be more contested than they currently are. The International Monetary Fund did begin opening up this kind of deeper discussion when its internal review of its early interventions in Greece suggested that the organization had been too quick to promote austerity. Yet the narrow terms of the troika’s conversations about the future of Greece suggests that there is an awful lot of room for more creative thinking about the path towards policy success, not just in Europe but around the world.

These kinds of debates about how we define and recognize success and failure can be crucial turning points in public policy. They force us, at least for a moment, to set aside some of our easy assumptions about what works and what doesn’t, and to ask ourselves what we really mean by success.

This blog post first appeared on the CIPS blog on March 6, 2015.

Canada, Finance, Measurement, Political economy, Results, Risk, Uncertainty

Why we need to take economic uncertainty seriously

Jacqueline Best

If you have been reading the financial press over the past week, you know that the global economy’s chances are looking a lot more uncertain these days. What you may not know, however, is that this more recent upswing in uncertainty and volatility is part of a much broader pattern in the global economy—one that poses some real challenges for how policymakers do their job.

Stephen Poloz, the Governor of the Bank of Canada, just released a working paper in which he suggests that the economic climate has become so profoundly uncertain since the global financial crisis of 2007-2008 that it resists formal modeling.

Because of this, the Bank will no longer engage in the policy of ‘forward guidance’, in which it provides markets with a clear long-term commitment to its current very low interest rate policy. The Bank is changing this policy not because it is any less committed to low interest rates in the medium term, but because it does not want to give the markets a false sense of security about the predictability of the future. Instead, Poloz suggests that policymakers should do a better job of communicating the uncertainties facing the economy and the Bank itself as it formulates its policies.

Why should we care about this seemingly minor change in the Bank of Canada’s policy? Because it underlines just how much our governance practices are going to have to change in order to cope with the increasing uncertainty of the current economic and political dynamics.

It’s ironic that this warning is coming from the Bank of Canada. Central banks do not like change. They are just about the most conservative government institutions around.

Since the late 1970s, central bankers have been wedded to the idea that the most straightforward monetary policies are the best—ideally taking the form of a simple rule that can be expressed as a quantitative target, like the Bank of Canada’s inflation target. Economists argue that such policy rules are stabilizing because they avoid giving too much discretion to central bankers, thus reducing uncertainty about the Bank’s plans and increasing the credibility of their commitment to low inflation.

Yet these simple rules are effective only as long as the models that they are based on can accurately capture an economy’s dynamics and needs. If the economy is too complex and uncertain for such straightforward forms of quantification, then simple rules are at best misleading, and at worst destabilizing.

Poloz’s recent paper suggests that he recognizes some of these dilemmas—and the importance of coming to terms with them quickly in the current period of economic volatility.

The Bank of Canada’s Governor is not alone in recognizing these uncertainties. Janet Yellen, the current Chair of the United States Federal Reserve Board, has also pointed to the limits of simple rules in guiding central bank policy in the current context. Her predecessor, Ben Bernanke, referenced Donald Rumsfeld’s concept of ‘unknown unknowns’ to describe the extreme uncertainty that faced market participants during the recent financial crisis.

Yet, with this paper, Poloz seems to go further than his American counterparts in recognizing the implications of these unknown unknowns. In the same speech cited above, Bernanke argued that the failures of the global financial crisis were failures of engineering and management, and not of the underlying science of economics.

Poloz, by contrast, describes the work of monetary policymaking as a “craft” (not a science), and suggests that it is too complex to be treated as a form of engineering. The uncertainty that we are dealing with today, he suggests, “simply does not lend itself as easily to either mathematical or empirical analysis, or any real sort of formalization.”

This is a remarkable departure from the kind of numbers-driven rhetoric that we have heard from the Harper government in recent years.

The Canadian government has been increasingly preoccupied with measuring results, in health care, international development, and across government-funded programs. Last May, when announcing additional funds for the health of mothers and children in developing countries, Stephen Harper argued, “You can’t manage what you can’t measure.

Poloz’s paper suggests that, on the contrary, because of the sheer complexity and uncertainty of the current global order, we have no alternative but to find ways of managing what we can’t measure. As I argue in my recent book, rather than using ever-more dubious indicators and targets to drive policy on everything from health to the economy, we need to find better ways of assessing, communicating and managing the true complexity of the policy challenges that we face.

This will not be an easy task, either technically or politically. It will take time to educate a public—not to mention a market—that has become used to simplified pronouncements.

The less we can rely on objective measurements and simple rules, the more careful we have to be about ensuring democratic accountability for policy decisions—through the political process and through an informed and active media.

And perhaps the biggest challenge that this new reality presents is the need for our politicians to heed Poloz’s suggestion that they not only recognize the inescapability of “uncertainty, and the policy errors it can foster,” but that they wear them “like an ill-fitting suit . . . that is, with humility.”

Humility tends to be in scarce supply in political circles these days. That too will need to change if we’re going to develop the kinds of creative policy tools that we need to manage the uncertain times to come.

First posted on the CIPS Blog.

Canada, Political economy

The austerity trap

Jacqueline Best

As the prognosis for the global economy gets darker by the day, we are hearing one word over and over: austerity.  The British government has announced that it will extend its austerity measures past the next election in 2015. In Canada, Finance Minister Jim Flaherty has reiterated that the solution to the current economic crisis, both here and in Europe, is more “belt-tightening.”

But not everyone agrees about the virtues of austerity. Labour finance spokesperson Ed Balls called the British Government’s economic plans a “catastrophic error of judgment.” Two million British public sector workers are on strike over the effects of those austerity measures on their pensions. Closer to home, the former World Bank Chief Economist and Nobel-laureate, Joseph Stiglitz, recently told a Toronto audience, “Austerity is a suicide path.”

These critics are a diverse lot, including people affected by the cuts, Occupy activists, politicians of various stripes, and the leader of the International Monetary Fund. In different ways, they all point to some serious flaws in the current rush to austerity.  It’s worth looking at three of them:

1) The fallacy of composition (or: why Canadian debt isn’t just a bigger version of your family’s debt).

In a recent speech in Toronto, Flaherty noted that he’s applying to the federal government the same advice that he’s offering to Canadians: to tighten their belts and reduce debt. This sounds like it makes perfect sense. Except that it’s a classic error of logic that philosophers call the fallacy of composition: what is true of the parts is not necessarily also true of the whole.

Of course it makes sense for a Canadian family that has taken on too much debt to reduce it. But if all Canadian families at the same time reduce spending in order to pay off debt, then suddenly demand for goods drops, firms reduce production, and jobs are cut. As people lose jobs, it becomes much harder for households to reduce debt; in fact, they may have to take on more to pay the bills. And the risk to the economy is even greater if the federal government doesn’t step in to support demand but actually undermines it further by cutting back on vital services.

This same dilemma applies at the international level. Sure, Canada was able to get its act in order in the 1990’s through austerity measures (at great cost to our health system and infrastructure). But this was at a time when the Canadian economy and the global economy were in good shape.  And while we were cutting back, other countries were doing the opposite, taking up the slack. If everyone cuts back at the same time, there is no one left to keep the global economy going—making it likely that the outcome will be a deeper global recession and more, rather than less, debt in the long run.

2) The costs of austerity (or: why even the IMF thinks it’s a bad idea just now)

In a recent paper, IMF staff concluded that austerity measures do considerable damage in the short and longer term: “This conclusion reverses earlier suggestions in the literature that cutting the budget deficit can spur growth in the short term.” In other words, when someone tells you that austerity will stimulate short-term growth, they’re lying (or as Mark Blyth puts it in a brilliant short video on austerity, this is just about as believable as “a unicorn with a magic bag of salt.”)

What are the costs of austerity?  The IMF paper suggests that they include lower incomes in the short term and higher unemployment in the longer term. As more people become unemployed for longer, there is a real danger that unemployment will become entrenched. The costs of austerity are even higher in cases where a government can’t compensate by significantly lowering interest rates—as is the case today here and in Europe. Because of these very real costs, the IMF head, Christine Lagarde, is suggesting that countries like Canada and the UK not impose any immediate austerity programs while growth is fragile; instead they should be delayed until the economy is healthier. When even the IMF tells us not to impose austerity, and still the Conservative government insists on it, you have to wonder.

3) Inequality (or: whose belt are you tightening anyway?)

Not surprisingly, the IMF study also found that the costs of austerity are not equally borne by everyone. Reductions in wage income caused by austerity are three times larger than those from other kinds of income. It also notes that austerity will “add to the pain of those who are likely to be already suffering—the long term unemployed.” This means that working class people have to tighten their belts much more than others do, through job loss, reduced income and pensions, and the loss of services they rely on. As Blyth puts it: “This ‘common sense’ of austerity—of reducing public debt all at once through slashing services—involves a question of equity—who pays and who doesn’t. Those who made this mess won’t, while those who have paid for it already through the bailouts will pay again through austerity.”

Politicians proposing unpopular and foolhardy policies like to claim that ‘there is no alternative’. But there are alternatives, at least for those in Canada, the UK and other countries not struggling under the kind of crushing debt burden facing Greece. In his recent speech, Stiglitz proposed several suggestions, including investing in infrastructure and education (which would earn returns of 20-30%). The goal is not to reduce the amount that the government spends but rather to reduce government debt, which depends on the overall health of the economy. As Stiglitz notes, “Putting more people to work today means that over the next five to ten years the debt would be lower, GDP higher, the debt to GDP ratio immeasurably improved.”

Remember the unicorn next time you hear someone talk about austerity and growth in the same sentence.

First posted on the CIPS Blog on December 4, 2011.