Former OSFI deputy says central bank intervention through inflation targeting still the best economic lever
While the increasing pressure from unfettered government spending pushes Modern Monetary Theory (MMT) closer to mainstream adoption, a new note from the C.D. Howe Institute argues that pulling fiscal levers is not the solution to the Canadian economy’s woes.
“We need to turn a deaf ear to MMT’s song as we begin to emerge from the acute phase of the pandemic,” said Mark Zelmer, a senior fellow at the C. D. Howe Institute and former deputy at the Office of the Superintendent of Financial Institutions (OSFI).
Referring to a recent C.D. Howe paper he co-authored with Farah Omran, Zelmer acknowledged that MMT is very seductive for numerous reasons.
For one, it relies on a few correct propositions: the effectiveness of federal stimulus depends largely on how it’s used; Canadian-dollar denominated government debt does not necessarily crowd out private investments when the economy is not operating at full capacity; and government debt does not pose a credit risk for investors when the monetary printing press is under the issuing government’s control.
“A Canadian government that can print Canadian dollars will always be able to pay off its Canadian dollar debt,” Zelmer said. “But it is not true, as MMT implies, that governments can issue debt with impunity.”
One risk, he noted, is that Canadian and foreign investors may worry that a depreciation of the Canadian dollar relative to other currencies could dampen some of their returns from investing in Canada. Unless they believe the government can generate sufficient future income to service its borrowing, investors may therefore choose to move their money elsewhere in the world with just a few mouse clicks.
“Permitting the Bank of Canada to continue buying the federal government’s debt and keep interest rates low risks dislodging our inflation-control anchor after the economy recovers,” Zelmer said, arguing that it creates a moral hazard among government policymakers whose other priorities would likely make them less interested in keeping inflation in check.
And while Canada is arguably in the same position as other countries just turning the page on the pandemic’s most acute phase, he noted that Canada’s businesses and households are carrying more debt, with a larger share being acquired by foreign investors. That means the country is increasingly vulnerable to market perceptions about how its economic fortune will unfold.
