The EU's mess seen from Canada (bonus: fresh Mark Carney quotes) -

The EU’s mess seen from Canada (bonus: fresh Mark Carney quotes)

The Bank of Canada governor on the necessity of transfers from rich countries to poor ones


For any Canadians trying to keep track of the scramble to solve the European debt crisis (good overview here), certain elements of the story have to keep reminding us of our own economic situation. Two particular points of stark contrast stand out:

Firstly, Canada has kept its own currency, despite sharing a free-trade zone with the United States, something the eurozone countries gave up in order to gain the apparent advantages of the euro and monetary union.

Secondly, Canada is a highly decentralized federation, not altogether unlike the European Union is some (but obviously not all) respects, yet the EU hasn’t adopted anything similar to the Canadian system for automatically transferring wealth from richer to poorer parts of the federation.

The importance of keeping the C$ is sometimes underestimated. Back in the second half of the 1990s, when Canadian government deficits were being reined in, the Bank of Canada was able to keep interest rates low to provide some monetary stimulus as the economy was being fiscally squeezed. Here’s what Gordon Thiessen, the bank’s governor back in those turnaround years, said back in 2000 about how having a floating currency all our own helped Canada during a testing time of federal and provincial government cutbacks:

The United States also had a budgetary problem. But the need for fiscal tightening was much greater here and so was the effect of the corrective measures on total demand in our economy. To help the transfer of resources from the public to the private sector and so support overall demand in Canada, we needed lower interest rates here than in the United States. These lower rates were maintained through most of the period from 1996 to the present. In today’s globalized financial markets, such persistent interest rate differences in the circumstances I have described are possible only with a floating exchange rate.”

Thiessen called the C$ the “shock absorber” that softened the blow of a period of tougher austerity in Canada than was being experienced in the U.S. The governments of Greece or Ireland, Spain or even France, don’t have that policy option now. They chose the euro, which has its own advantages. For them, government spending restraint can’t now be cushioned—it can’t be offset by a lower currency and more relaxed monetary climate in a country that finds itself in worse shape than its neighbours.

In a recent Maclean’s interview, Mark Carney, the Bank of Canada governor, used the same well-worn shock absorber analogy as Thiessen did to describe the advantage of an independent, floating currency. But Carney swiftly moved on to discuss the other element of the current European Union crisis that looks striking from a Canadian perspective—the lack of transfer mechanisms to make sure wealth from rich members of the EU flows automatically to weaker members.

Carney suggested such transfers are essential. Here’s the full exchange from that Nov. 24 conversation (we didn’t publish it in the magazine with the original version of the Carney Q & A, because he had a lot of interesting stuff to say and we didn’t have enough space for all of it):

Maclean’s: In your speeches, you describe the Canadian dollar as a good vehicle for transmitting Canadian monetary policy. Given that it works for Canada, and given the situation of the European Union right now, isn’t the lesson that it was a mistake for European countries to give up their own currencies before entering into a true fiscal federation? Haven’t they given up a tool for adjusting to exactly the sort of crisis they are now weathering?

Carney: There’s no question that the exchange rate acts as a shock absorber. It facilitates adjustment. It allows for monetary policy independence. That’s absolutely true. In joining a monetary union, you very explicitly give up that lever. There are deeply held political reasons for European monetary union, but the quid pro quo of giving up the exchange rate lever is you better have a quite flexible economy so that you can adjust to inevitable changes to relative competitiveness.

You can do it through productivity, flexible wages, people moving across borders as necessary. Just as within the Canadian economy, as the fortunes of different regions change, those adjustments take place in our economy. We have quite a flexible economy. That lagged in Europe.

Then, on top of that—and this is part of re-founding monetary union—you’ve got to make it more flexible, and not just make declarations about doing it—you actually have to do it. A fundamental question for [Europe’s] monetary union, re-founding it, is, ‘Are you going to have some automatic stabilizers, or redistribution through some form of federal fiscal role within Europe?’

We very much have that in Canada, even in one of the most decentralized federations. And it’s not just about equalization and transfer payments. Just think about the way the tax system works. We take less taxes out of Alberta when energy prices are down and activity is down, and there’s more transfers to individuals net from the federal purse at that time as well.

The points Carney raised are very much being hashed over in Europe right now.  (Over at Der Spiegel, for example, there’s a fascinating debate between Joachim Starbatty, economics professor emeritus at the University of Tübingen, and Peter Bofinger, a University of Würzburg professor and member of a German government economics advistory panel.) A splintering of the EU and a return, in at least some countries, to independent currencies is clearly possible; so is a closer fiscal union with  some sort of transfer system, and less flexibility on spending for member countries.

Whatever the outcome, and at the risk of indulging in the new national smugness, I’d say Canadians will have reason to feel thankful. Fairly vigorous past attempts to nudge Canada towards giving up its currency (like this 1999 report from the C. D. Howe Institute calling for currency union with the U.S.) went nowhere. Despite periodic strains, the federal-provincial system of transfer payments that makes the fiscal federation work remains intact and robust.

As the news from across the Atlantic reminds us anew almost every day, the value of these fundamental aspects of the distinctive economic system we’ve inherited shouldn’t be taken for granted.