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Inflation is a problem, and it results when there is too much money chasing too few goods (and services). Or as one economist said it, “inflation is always and everywhere a monetary problem.”
But inflation isn’t a problem if there isn’t any.
1/ https://twitter.com/pierrepoilievre/status/1344312291492122633
But inflation isn’t a problem if there isn’t any.
1/ https://twitter.com/pierrepoilievre/status/1344312291492122633
The Bank, which is charged with delivering monetary policy (and executes that policy completely independently from political direction), has forecast that inflation will remain *below* its target for an extended period of time.
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There is slack in the economy (an “output gap”) meaning that the economy is below capacity. There is room to increase goods and services along (by creating more jobs, increasing productivity, expanding capital investment, etc.), so we aren’t in an inflationary environment.
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Hence, monetary stimulus can be used right now in order to help boost the economy. And monetary stimulus works mainly by affecting interest rates. Which is what the Bank is doing.
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One thing the Bank has been doing is buying bonds (primarily government bonds). Bonds can be bought and sold at any time, and will frequently trade at a price other than face value. A bond’s price largely depends on the interest it pays (coupon rate) and its maturity date.
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A bond with a relatively high coupon rate will trade above par. Because if you have a choice between buying two bonds, one which pays $1,000 in interest per year and the other $500, you will choose the first one all else equal.
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So, as interest rates decline, existing bonds will appreciate in value because their (fixed) coupons become more attractive. This has got Mr Poilievre in a knot, because poorer people don’t tend to own bonds.
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Note that this gain in value is only realized if you sell a bond prior to maturity. If you hold the bond, you will continue to get the fixed coupon payments and eventually the par value of the principal amount on maturity.
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For rich/institutional investors who do sell and realize a gain, they now must figure out what to do with the cash they just got. If they buy another bond, they will either have to pay a premium price or get a new bond that has a much smaller coupon rate.
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They can buy stocks, but this is only a good idea if they can expect the companies to be profitable and give them a return better than bond yields (stocks are a riskier investment, so you won’t buy them if you can do just as well with much safer bonds).
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Companies will try to get those higher returns by making investments that increase their revenues and/or lower costs. They may also borrow money (because debt is now cheaper!) to help do that. More investment ==> more economic growth.
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Rich people might also just choose to go on a spending spree. Why save if the returns are awful? Who doesn’t want a 6th Mercedes? More consumer spending ==> more economic growth.
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For the poor people who don’t own bonds, whom Mr Poilievre’s concern seems to be directed, we’ve already noted that there isn’t any inflation to shrink their buying power. But they don’t just tread water — monetary stimulus can benefit them, too.
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First, more economic activity ==> more jobs, which in turn can lead to higher wages. But these people can also benefit from lower interest costs on their debt. Mortgage up for renewal? Looking to finance a car? Paying off student loans?
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Now, not everyone benefits to the same degree from monetary stimulus. New jobs only benefit the households of the people who get those jobs. Lower debt costs only benefit those who have the credit score to secure that debt, etc.
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This doesn’t invalidate monetary policy as a tool. It just means that it has its limits and other tools need to be used to address inequity.
Generally, albeit not accurately, it’s called fiscal policy — economic measures put in place by government (not the Bank).
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Generally, albeit not accurately, it’s called fiscal policy — economic measures put in place by government (not the Bank).
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But it is wrong to suggest that monetary stimulus is a transfer from poorer households to high wealth households.
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And what happens if inflation becomes a problem? Monetary policy isn’t a constant. As the economy picks up speed, the Bank eases off the accelerator. Eventually, it starts raising interest rates to stop the economy from overheating and keep inflation under control.
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That’s bad for existing bond holders (who see those existing bonds fall depreciate — the reverse of what happens when interest rates fall) and for people looking to borrow money/renew mortgages. But on the plus side, they are benefiting from the stronger economy.
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I should reemphasize that the Bank makes these decisions independently from political direction. It doesn’t set interest rates based on what the Minister of Finance or even the PM wants. In fact, the Minister will very carefully never say what the Bank should decide.
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This is because people have to have confidence in how monetary policy will be executed in order for it to work properly. Governments can easily be tempted to keep interest rates low in order to inflate away government debt and keep debt servicing costs low.
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Bank independence prevents that conflict of interest from arising. And this means people can make economic decisions (such as to borrow or lend, or to invest capital) confident that inflation won’t suddenly undermine their decisions.
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It is thus unfortunate that Mr Poilievre is implying that the Government is somehow causing the Bank to finance its debt, which in turn is causing inflation to transfer wealth from poorer households to wealthier ones.
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There are many valid criticisms of the decisions being made by the current Government. It would be preferable,
IMO, if the Finance Critic focussed on those instead of making claims that anyone who understands even introductory macroeconomics knows are bunk.
/fin
IMO, if the Finance Critic focussed on those instead of making claims that anyone who understands even introductory macroeconomics knows are bunk.
/fin
