Bank of Canada Deputy Governor John Murray gave a speech Tuesday, the gist of which was that Canada has benefitted in the past five years from a world awash in easy money. But we’ll have it even better, he says, when countries — namely the U.S — start to turn off the taps.
The speech to the Canadian Association for Business Economics put a good-news spin on the panic that has swept through global markets since May when Federal Reserve Chairman Ben Bernanke suggested the U.S. might start to cut back on the $85-billion monthly bond-buying spree known as quantitative easing some time this year.
The reaction, dubbed the “taper tantrum,” sent U.S. stocks and bond yields soaring and boosted mortgage rates. It’s been felt here in Canada too, through rising mortgage rates and a lower dollar. But the effect has been most pronounced in such emerging markets as Brazil, India and Indonesia, which have seen their currencies fall dramatically as investors pull out their cash. Last week, Brazil announced a $60-billion intervention to prop up its currency, the real. It has prompted warnings, including this one from International Monetary Fund head Christine Lagarde that the U.S. and other advanced economies should hold off on plans to tighten their monetary belts.
Not to worry, Murray says, it will all end well, particularly for Canada and for any country that has managed to keep its fiscal house in order during the era of unconventional monetary policy.
The end of quantitative easing in the U.S. and the eventual end to low interest rates here in Canada, he says, “should be viewed positively, as a sign that the global economy is well on the way to recovery and that it is time for interest rates to begin normalizing.”
Here are some highlights from his speech:
- Despite the market panic surrounding the mere prospect of the end of quantitative easing, the process, he says, will be gradual. “The exit would be preceded by a gradual decreasing in the size of asset purchases, followed by the end of asset purchases, a gradual withdrawal of excess liquidity from the system, measured increases in the federal funds rates and, eventually, a normalization of the Fed’s balance sheet.”
- There will be spillover of the Fed policies around the world, including in Canada, but spillovers can be good. “Actions taken by one country that are in its own long-term interests (keeping its house in order) typically benefit others (keeping the neighbourhood safe).”
- Governments and organizations, including the IMF, who have called for more global co-ordination among central banks when it comes to ending unconventional monetary policies, are misguided. “Following the advice of their critics would oblige the United States and several other [advanced economies] to surrender some of their monetary policy independence. In our view, however, this would be a Faustian bargain.” A better solution, he says, should be “allowing exchange rates to float, while preserving the free movement of capital and monetary independence for all.”
- So far, says Murray, America’s extraordinary simulative monetary policies have been good for Canada, since the influence of lower interest rates and a higher loonie “were more than offset” by stronger demand in the U.S. for Canadian exports, a boost in asset prices (such as housing) and a commodities boom. “Fed easing was a net positive for Canada, making a difficult situation better.”
- But the end of quantitative easing will be even better still, he says. Interest rates will go up and the loonie will fall. But the improving U.S. economy will “more than compensate from a drag from higher interest rates. Stronger external demand, coupled with downward pressure on our currency and support for commodity prices from a global economic recover, will provide the lift.”
- Granted, he warns, it’s unlikely to all go perfectly as planned. Markets have a long history of overreacting to such changes — which have caused things such as the price of stocks or bonds or houses to collapse at various points in the past. But this time is different, Murray says. Central bankers are committed to more transparency and better communication about where monetary policy is headed, which should lead to fewer nasty surprises. The end of quantitative easing in the U.S. “should be one of the best telegraphed events in monetary history,” he says. Whatever pain is felt in the economy will be “transitory, with markets settling at levels consistent with fundamentals after a short period of time.”
Let’s hope he’s right.