In conversation: Mark Carney

On Europe’s crisis, fighting inflation, and his new job heading the financial stability board
Bank of Canada Governor Mark Carney in Ottawa November 25, 2011. Photo by Blair Gable for Maclean’s Magazine
On Europe's crisis
Blair Gable

He’s among the most respected voices anywhere on financial regulation and monetary policy, and the Canadian closest to the centre of efforts to solve the European debt crisis. Governor of the Bank of Canada since 2008, Mark Carney, 46, was also recently named head of the Swiss-based Financial Stability Board. He’s a leading figure in the struggle to shore up a fragile world economy.

Q: Let’s talk about Europe. You hear people saying we may be in the last days of the euro. What is the way out of this crisis?

A:Let me say two things. One, there are longer-term issues that absolutely have to be addressed. They have to rework the way the monetary union functions—fundamental questions of competitiveness in these economies—which require multi-year reform programs. Those absolutely have to be done for this thing to work in the medium term—and there’s no point saving it in the short term, if it’s not going to work in the medium term. But in terms of creating the bridge so there’s time to do all of that, we have long advocated that they create a mechanism—a firewall—that ensures that all eurozone countries can fund themselves at sustainable rates for the next two, three years. And that is a requirement that is at least on the order of a trillion euros.

Q: Who can provide that much liquidity?

A: There are a variety of different ways, some involve the European Central Bank, some involve this European Financial Stability Facility (EFSF). It could involve the IMF or it could involve a combination of those three. But they have the means in Europe to deal with this. This is a manageable problem, if it’s managed, but it’s coming up against the political will to manage it.

Q: There’s already a large pool of money in the EFSF. Why isn’t that sufficient?

A: We think the money and guarantees that have been put into the EFSF are being used inefficiently, and now is not a time to use money inefficiently. They need to be more inventive, or as inventive as possible in terms of maximizing the impact of the considerable guarantees that they put in place. They have to decide how effectively to use it, or they have to decide whether to go other routes.

Q: As in the European Central Bank?

A: The European Central Bank has a very clear price stability mandate. But the question ultimately could, given the economic outlook in Europe, become: what is the necessary amount, and the appropriate way to provide stimulus to the European economy, in order to achieve their price stability mandate? So it’s absolutely guided in our opinion by that mandate, not some magical printing press that the ECB should just run and solve this issue because it’s too inconvenient for the political class to solve it. No, the political class has to make these decisions.

Q: You say in your speeches that the Canadian dollar is a good vehicle for transmitting monetary policy. Is the lesson from Europe that it is a mistake for countries that aren’t in a true fiscal federation to give up their currencies?

A: There’s no question that the exchange rate acts as a shock absorber, it facilitates adjustment. It certainly allows for monetary policy independence. In joining a monetary union, you very explicitly give up that lever, but the quid pro quo is that you better have a quite flexible economy so you can adjust to inevitable changes in relative competitiveness, and that you can do it through productivity, flexible wages, people moving across borders as necessary. That lagged in Europe. And this is part of refounding a monetary union, you gotta make it more flexible, and you actually have to do it, not just have declarations about the desirability of doing it—you actually have to do it.

Q: Your view, then, is they can and should try to save the euro? Some would say better to kick Greece out, for example—that the costs of trying to save it are worse.

A:Under any adjustment scenario, they will pay. There are fundamental adjustments required in these economies under any scenario, and they need to get on with those. And that is going to require additional fiscal resources from European partners before anyone else thinks about providing additional resources to Europe.

Q: What powers does your job at the Financial Stability Board entail, beyond the bully pulpit?

A:It’s not a treaty-based organization. What it does have, though, is a little more than the bully pulpit because these reforms [to financial regulations] that are under way are the product of a process where all the major economies are around the table and they’re participating in their development, and then they agree ultimately at the leader level in the G20. So you have the highest political signature on these reforms, and therefore there’s an expectation they’re actually going to be implemented. So we’re going to run formal audits, basically, of these things and one of my jobs is going to be to go back to leaders if there’s an issue and call people out and say, you know: “We have a problem here. You signed this communiqué in 2009 that meant that, and you’re not implementing it, and this has repercussions.”

Q: What’s the agenda: how much has been done, and how much is there still to do?

A: There is a lot that still needs to be done. We’re not in a position, today, to say too-big-to-fail is over: it’s still an objective that we’re working toward. The elements that are crucial for it include moving most of derivative activity through central counterparties. This year, 2012, will be the year for getting over that hurdle, which is incredibly complicated, hundreds of trillions of dollars of activity that has to be sorted out. Separately, the entire approach to the other half of the financial system—the shadow banking system—where do we draw the line in terms of regulation? And we’ve gotta be careful about this one because, you know, there are some who want to regulate absolutely everything, which is a recipe for stasis or disaster: you end competition, you lose diversity in the financial system, you lose all the benefits of a parallel system. But certainly we have to avoid regulatory arbitrage. We have further work to do on cross-border resolution: if a large bank were to fail, how do you take it apart, how do you share it out between regulators? We’re working on that.

Q: But to be very clear, the end point is no more too-big-to-fail? No matter how big you are, if you fail you fail?

A: You fail. In my opinion, that is the only viable objective. You can’t prevent institutions from failing. I mean, it will happen, inevitably. It has to be that when the institution fails that it’s borne by the shareholders, then their debt-holders, but not ultimately the taxpayers. That’s got to be the objective because that’s a market system. Plus, politically, the alternative is quite unacceptable.

Q: Sticking closer to home, Canadians have come to trust the Bank of Canada to keep inflation low, but you’ve referred, in recent weeks, to the need for “flexibility” in inflation targeting. Can you reassure us that you’ve not gone soft on inflation?

A: Yes. We have always practised flexible inflation targeting in this country. The word “flexible” hasn’t always been there, but the concept’s always been there, and it’s been there in the practice.

Q: You decided to renew the five-year inflation target more or less as is and not tighten it as some analysts had been hoping.

A: We looked at it and said, “In a perfect world, would it be better to target a lower level of inflation?” Yes, you know, according to economic theory and kind of according to intuition. The challenge would be that we would get to the zero lower bound [on interest rates] a lot more frequently if we did have a lower rate of target inflation. It’s 16 times more likely that you’ll be at the zero lower bound with a zero per cent inflation target, versus a two per cent target. That would mean using more unconventional monetary policies, and the issue becomes how effective are these policies, and would you want them to become, in effect, conventional policies. And the answer is no, we don’t want to be in that position.

Q: We think of central banks as mostly being in the business of keeping inflation under control. But you’ve also talked about the need to stabilize financial markets, even “leaning” against asset price bubbles. How does all that fit together?

A: Two things were reinforced during the crisis abroad. One is that price stability is not a guarantee of financial stability. But it’s even stronger than that: a period of relatively stable prices and relatively low and stable interest rates actually can feed financial excess. Second, it’s not about asset prices, it’s about credit creation, and that’s when you have to start to really worry. How do policy-makers address that? The first line of defence is absolutely not monetary policy. The first line of defence is the institutions themselves. Second, you have regulation and supervision on a micro basis, bank capital, those type of things. And then thirdly, what’s new is to use sort of macro tools, macro regulation, that will also help moderate the cycle. At a minimum, you don’t want to be working at cross purposes with those tools, and sometimes when those imbalances are economy-wide you’re going to want to lean with monetary policy. That, all things being equal, is going to leave inflation lower for a period than it otherwise would be. But when it comes right down to it, what’s our job? Our job’s to get two per cent inflation, our job’s to ensure that Canadians don’t have to worry about inflation—they’ve got lots of other things to worry about—and we’ll continue to do that job.