The Decibel - High interest rates and The Bank of Canada, explained

Episode Date: October 18, 2023

With inflation still stubbornly high, it seems like interest rates could remain elevated for quite some time. And the stress of that has some Canadians wondering who gets to make these big economic decisions.Report on Business columnist David Parkinson explains the relationship between the Bank of Canada and the federal government, how interest rates are set and what changes might be worth considering when it comes to changing how Canada’s central bank works.Questions? Comments? Ideas? Email us at [e-mail]

Here's how Report on Business columnist Dave Parkinson wants you to understand the Bank of Canada. Central banking is like plumbing. When it's working, we give it no thought whatsoever. It's just there. But here's the thing. Lately, our plumbing has been kind of leaky. Inflation is still high. In fact, new numbers out Tuesday put it at 3.8 percent,

still nearly double the Bank of Canada's target of 2 percent. So now we're thinking about how do we fix this? What's wrong with this? Why isn't it working? Calling people, yelling at people because we don't get it. And that's why we don't get it, because when it works, we never think about it. The fix for these leaks, according to the Bank of Canada, is to raise interest rates. They're currently at 5 percent, and we're expecting another decision on them next week. So, you know, the plumbers are working hard and we're standing over them wondering why it's costing us so much. Today, we're going to talk to Dave about the plumbing of Canada's economy, so we can really understand how it works, what people's concerns are, and what can be done about it all. I'm Maina Karaman-Wilms, and this is The Decibel from The Globe and Mail.

Dave, thanks so much for joining me. Thanks for having me. So Dave, Canadians have been, of course, feeling the impact of higher interest rates. And probably as a result, a lot of people now have opinions about the Bank of Canada and what it's doing, right? But when it comes down to it, people are really feeling the strain. So is everything as bad as it can sometimes seem? It depends on who you are. Increasing interest rates, falling interest rates, they apply across the entire economy,

but they don't affect individual households, individual businesses the same way. So what they're seeing is they kind of expected that it would hit the poorest people in the economy, the lowest income people, the hardest. But what they've also found is that actually some of those same pressures have actually been helping some of the lowest income people in the country in that the inflationary pressures have been tied very closely to a very strong labor market, which has been helping people at the bottom end of the labor market. It's been improving job availability, and it's been improving wages in a way that we haven't seen probably in a generation. In fact, disposable income has actually gone up. So in a weird way, though, that's helpful for people in low incomes because their wages are going up, but unhelpful to the Bank of Canada

because it's trying to slow down consumption. And it's actually seeing a little more consumption than it maybe had expected to see from some of the people it expected would get hit hardest. So it sounds like this is both helping and hurting kind of the Canadians with the lowest income. There's two sides. And it's going to, and again, it's going to depend a lot on how much debt do you carry? The people who carry a lot of debt get hit harder. It turns out that the people who are being hit the hardest in terms of their debt to disposable income ratios, which is a really good

way of measuring how severe your debt load is. The people who are getting hit the hardest are sort of the middle of the age range, kind of 35 to 55, because those are the people who hold the bulk of the mortgages. Strangely, though, people younger than that, sort of the 20 to 35, they're actually doing better in terms of their debt loads. And we can only theorize on this, but it seems like what's probably happening is that they're just not buying houses because it's become too expensive. The mortgage rates are too high. They're holding off being in the market. That's actually giving

them a little bit more flexibility in terms of disposable income. So again, the bank is trying to gauge where these pressures are landing and whether they're actually having the desired effect. That's the plumbing, right? This is the plumbing within this whole process. Okay. And when we're talking about interest rates, I think it's fair to say, honestly, that people are paying attention to it now, but I think there's a lot of public confusion really about how these rate hikes actually get made, right? So, Dave, I guess what's the number one thing that some people get wrong about these rate heights and the Bank of Canada that's making them?

Well, the big thing, and there was a survey that came out from Abacus Data a couple of months ago. And it was quite a broad survey. It was about 2,000 people. So it was a pretty large sampling of Canadian opinion. And it found that nearly half of Canadians believe that either the federal government tells the Bank of Canada where to set interest rates or that the federal government sets the rates themselves, both of which are wrong. Some of this probably political rhetoric has probably contributed to this because there's a belief that, you know, Justin Trudeau is the reason we have high interest rates. So then in people's minds, it's the government has been raising interest rates, but it's not the government. The central bank operates independently

from the politics of the federal government. Okay, so let's actually get into this then. What exactly is the relationship between the Bank of Canada and the federal government? It is very much an arm's length relationship. The Bank of Canada is a federal government agency. It's owned by the government. What the government does is it appoints a governor. It does that once every seven years.

It appoints the senior deputy governor, which there's a little more flexibility in there, but it's also a seven-year term. Sometimes they overlap a little bit. But again, the two top officials of the bank are in fact appointed directly by the prime minister, the finance minister. There is a five-year agreement between the government through the Department of Finance and the Bank of Canada on what it is that the bank is mandated to do. The mandate is aim for 2% inflation. Okay. And that has been the case for about 30 years. And once that mandate is set, the government steps back and says, you figure out how to do it. That's your

job. We don't step in. We don't interfere. We don't tell you how to do it, when to do it, why to do it. We have conversations every once in a while. We get on the phone, we have lunch. I mean, almost literally, but that's about it. It tends to be sort of big picture economic policy kinds of conversations that they have, not specifics of you should raise rates now, you should lower rates now. It's helpful for the government to know what the bank is thinking. It's helpful for the bank to know what the government is thinking in terms of its fiscal policy, its spending plans, its taxation plans, because all of this stuff interacts, obviously, economically. But they are very careful not to tell each other what to do.

So who else makes up the Bank of Canada? Because you mentioned, Dave, that the prime minister appoints the Bank of Canada governor. But I guess who else is in charge at the Bank of Canada and who's hiring them? Officially, our interest rates are set by the governor of the Bank of Canada. In the Bank of Canada Act, which goes back about 90 years, since the 1990s has been what's called the governing council, which is the governor and all of his deputy governors. There's a total of six of them at the moment. They are a body that work together on a consensus basis to make interest rate decisions. Sometimes they bring in people from the outside. There is currently sort of a new twist

that the bank introduced this year, which was to have an independent member of the governing council who has had no previous connection with the bank and is considered completely an outsider from the bank's sort of longstanding group that works together to form the policy. So they brought in somebody as a sort of an independent voice on the panel.

Was that the motivation behind that change to get, I guess, get a different perspective? Yeah, yeah. And it's, you know, it's one of the things that a lot of central banks in the world have been increasingly doing is trying to broaden the base of their decision making. And I mean, this is obviously one of the things that people have become concerned about, because now that they're actually looking at this process, they're asking themselves, well, who are these people who are making the decisions and who voted for them? Well, the answer is that nobody voted for them. Then the question becomes, well, why this group of people and not some other group of people?

I want to go back to something you mentioned a bit earlier, Dave. You said that the bank was set up to be independent. Why is that? Why was the bank set up to be independent in the first place? Well, I guess the answer to that is look at the places in the world where central banks have not operated independently. And it tends to go very badly. When politics interfere with monetary policy, tough decisions are either not made at all or made very badly. One example of the danger was during Donald Trump's administration when he would actively criticize the head of the Federal Reserve.

He wasn't directing them on what to do, but he was strongly suggesting that he wanted a certain interest rate policy that wasn't consistent with what the head of the Fed wanted to do. And of course, the Federal Reserve is the central bank in the states. Yeah. But at any rate, the big concern at the time was that Donald Trump would, in fact, interfere and direct the bank to lower rates, even though it was counter to any logical economic sense. But his concern was to maximize economic growth, to maximize profits, to maximize returns in the stock market. These are not the goals of monetary policy. Monetary policy is meant to be a stabilizer.

Yeah, so you don't necessarily want a politician who's maybe thinking about the voting public to be making these decisions. Well, I mean, you put yourself in the situation we're in right now. And how many votes could you get if you said, if you elect me tomorrow, I will cut interest rates by two percentage points. You could do very well. Would it be good policy? No, it'd be horrible policy. You'd end up with a much bigger economic problem than we have right now. Can you just spell this out for us, Dave? I mean, you're thinking about this all the time, but for people who are not as well-versed, what would be the danger of just slashing interest rates to like 2% overnight? If you cut interest rates, what you would do is actually stimulate more demand.

We've already got too much demand. If you think we have an inflation problem now, cutting interest rates by two or three percentage points overnight would cause a tremendous inflation problem. We'll be right back after this message. So to recap a little bit, there's Bank of Canada. It's got a governor. That person is appointed by the federal government. But the bank is independent from the federal government in terms of the decision it makes

to raise or lower interest rates is the big one, right? So I guess what do we know, Dave, about how those decisions are made when it comes to setting interest rates? We do know that the governing council gets together every six or seven weeks. We know generally how the process works. We don't know specifically what is said in the room. We know that when they come out of the room, they announce their decision, they provide a short explanation of what their decision is. We don't always know how they come to the decision. We don't always know how they come to the decision. We know more now than we used to.

The bank has been getting better and better at being transparent. But ultimately, we don't know what each of those six people who make that decision, we don't know their specific individual opinions. We don't know what objections some of them may have raised in great detail or who raised them. We don't know how unanimous the decision is. Officially, it was by consensus them. We don't know how unanimous the decision is. Officially, it was by consensus, but we don't know how unanimous it was. There could be a couple of outliers who get talked into it in a meeting, but we have no way of knowing that. Do we have any idea of the things they consider though, at least when they're talking

about these things? We do now. The bank, as of this year, has been publishing what they call a summary of deliberations. Now, this was a long time coming and the bank actually resisted it for a long time. They wanted their conversations to be entirely confidential. And so, so that the people in the room would feel, I guess, free to say whatever they wanted to say to whomever they wanted to say it within the walls of that meeting. So now what they've done is they've come out with something that does not quite tell you who said what, but it is a summary of the conversation that they had in those meetings leading up to the decision. Okay, so transparency is one of the criticisms. It sounds like they're trying to do a little bit to alleviate that.

But are there any other common critiques, I guess, Dave, of the bank? Well, and I think that's probably the biggest one is that it's a black box. And again, this is an extremely powerful group. Being the governor of the Bank of Canada is maybe the single most powerful economic position in the country, unelected. It's just, it's a natural criticism of why does somebody with so much power is not really answerable to anybody. Yeah. So that's like, I guess, a question of accountability right there then. Yeah. And I think there is, I think there is accountability, but it's, it's informal. It's not, and it's not frequent.

Governors do go on a regular basis and speak to parliamentary committees, both, both in the Senate and in the House of Commons. It's regularly scheduled. It happens multiple times a year. It's not as if there is no political oversight of this group. I would say that having listened to these testimonies many times in the past, they're not particularly deep.

The people who are on these parliamentary committees probably don't have as strong an understanding as they should of what the bank is doing, frankly. In terms of scrutiny of day-to-day operations, in terms of scrutiny of individual policy decisions, it's public scrutiny more than anything. It's the stuff we're talking about is probably the most scrutiny that the governor has. I guess with the question of accountability here, I mean, the prime minister appoints the governor. Does that also mean that they could fire one? And isn't that a way maybe to also hold the bank accountable? Well, I think Pierre Polyev has suggested that that's entirely a legitimate way to make the bank accountable. In practice, it has literally never happened. It came close

in the early 1960s with James Coyne. What was that situation? Well, Coyne and the Dieffenbaker government had some fundamental disagreements. And in fact, Coyne was giving public speeches telling the government what he believed it should do in terms of fiscal policy. The government started leaning back hard against him, telling him what to do in terms of monetary policy. It kind of came to a head where it was, you know, either you quit or we fire you. Coin quit.

So the process now is that there's something actually built into the Bank of Canada Act called the government directive. So if the Bank of Canada governor is setting monetary policy in a way that the finance minister believes is fundamentally flawed, the finance minister can go to the governor and say, this is what we want you to do. It is assumed that if a government took that extreme move, the governor would resign. It's assumed that it would create financial chaos, a loss of

confidence in a central bank governor. It would gut the value of the Canadian dollar overnight. It would gut the value of the Canadian stock market overnight. It would be a mess. Wow. Okay. So even though, as you say, Pierre Palliev, the leader of the conservatives, is talking about it, if he were to be in power, this might not actually be a good move. No, and frankly, I don't even know what he would advise the next governor to do other than what this governor is already doing. His objection is that we got in this problem with inflation in the first place. His objection is with what the governor didn't do a year and a half ago,

not with what the governor is doing now. So it would be kind of odd for him to fire a governor and replace him with another governor executing exactly the same policy. Interesting. Okay. Okay. So Dave, we've talked about kind of like, you know, few things here and there that the bank has been changing. I wonder, are there any broad changes that the government could make to address the concerns that people have around the Bank of Canada? Well, there are. Whether the government was prepared to do that kind of thing, I don't know. In Australia, their government and their public were upset enough about the direction of

interest rates, about the direction of inflation. And one of the things they came out with was a notion that instead of having so much power in the hands of the governor or the governor and a few people who work with the governor, they came out with a whole range of proposals. But a key one was to set up a new body of a new panel of basically independent experts who would set the policy and have the governor be one member of that panel. Now, a similar proposal has recently come up in a bill that was tabled in the Senate. Diane Belmar is the senator who tabled it. And that is the centerpiece of her proposal, is to get rid of the governing council, which

is effectively a bunch of Bank of Canada employees with, as I said, one exception now, one external expert, and to make it a panel that is majority external experts. It's still not an elected body. At least it's one that is a little bit less sort of internal clubby, might have a more diversified range of opinions. And maybe that would be a more robust decision-making process. Interesting. So you said this was a bill introduced in the Senate. Yeah. I guess, what are the chances here then? Is that happening? It's essentially a private member's bill. But the whole idea is, let's get people talking about this. Maybe there is a model that makes more sense than the one we're doing is maybe more publicly

responsive. Maybe inflation as the sole objective is not enough. Maybe we should be looking at another thing. That's one thing that Diane Belmar's bill does talk about is saying maybe Canada needs a dual mandate. Lots of other governments do. Usually it means looking at inflation and maximizing employment at the same time. Instead of just looking at inflation, basically. Yeah. And it's difficult

to do because those two things aren't always consistent. But a lot of other central banks have done it. The Fed in the US has a dual mandate. It's not impossible to try to juggle these two priorities and put them essentially on an equal footing. I should say that the last five-year renewal that the Bank of Canada had in 2021 does in fact talk about maximizing employment, but as a secondary goal. It's all worth talking about. Just because something was set in law somewhere and it's always been done this way doesn't mean that it always should. Yeah. A big question I have here, Dave, is we've talked a little bit about kind of politicians and they're wading into this now, right?

And this is also why people are hearing opinions about the Bank of Canada. How do we keep this discussion from being so partisan? Because I think that's a big part of what we're seeing these days in federal politics, and this is informing people's opinion about the Bank of Canada. I think as the public, as voters, we need to be smarter about this stuff. We need to understand it better ourselves. We need to educate ourselves better on it. If we don't want partisan politics to take over the discussion, we have to demand that our elected officials have those discussions on a higher level, on a realistic

level. We need to have our leadership not just upset that the plumbing's not working, but actually go to the trouble to understand what the problems are and try to address them with meaningful policy. Dave, thank you so much for taking the time to walk us through all this today. Oh, it's my pleasure. That's it for today. I'm Mainika Raman-Wells. Our producers are Madeline White, Cheryl Sutherland,

and Rachel Levy-McLaughlin. David Crosby edits the show. Adrian Chung is our senior producer, and Angela Pachenza is our executive editor. Thanks so much for listening, and I'll talk to you tomorrow.