Ottawa’s asset: an independent central bank

It was a relief when U.S. President Donald Trump nominated Kevin Warsh as the new chair of the Federal Reserve last month. A former Fed Governor, Mr. Warsh is seen as a steady hand unlikely to upend the U.S.’s central bank.

But sadly, the threat to the Federal Reserve’s independence remains high. If Mr. Trump does manage to influence the Fed’s decisions, there will be serious consequences for the global economy.

Canada needs to be ready for the increased volatility that could follow. But there could be an upside: The situation underscores Canada’s advantages in the global economy, a stable political climate and a central bank that remains free from interference.

The current Federal Reserve Chair Jerome Powell is still under criminal investigation, a move he said was meant to intimidate him into fulfilling Mr. Trump’s wish of lowering interest rates. The Trump administration is also trying to remove Fed Governor Lisa Cook. If Mr. Warsh is confirmed by the Senate, he will find himself under immense pressure to lower rates, regardless of the country’s economic situation.

Academic research shows that countries where central banks lack independence tend to have higher inflation and higher levels of government debt. Argentina, Turkey and Zimbabwe have suffered periods of high inflation following the erosion of central bank independence.

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Bank of Canada Governor Tiff Macklem has warned that a loss of independence at the Fed would have a big impact on Canada. Already, investors seeking to avoid the increasingly unstable U.S. have taken money out of the country, causing the Canadian dollar to appreciate against it. Increased doubts about the U.S. could see a further rise of the Canadian dollar, hurting exporters, while reducing costs on imports.

If political interference with the Fed becomes routine, it could tie Canada into its political cycle, says Moshe Lander, senior lecturer in economics at Concordia University. U.S. rates could drop in the lead-up to elections, creating capital flows into Canada that would boost the loonie, with the trends reversing after voting day.

Even without direct political interference, a loss of confidence in the Fed could cause inflation to build. If the Fed’s inflation-fighting reputation suffers, workers may demand higher wages and firms may raise prices. When this happens, larger rate hikes are often needed to bring inflation down, which could result in higher rates in Canada as well.

Fortunately, confidence remains high in the Bank of Canada. As a result, this country benefits from being seen as a relatively stable place to invest and to grow a business. Jurisdictions that have political and legal stability are good places to invest; an independent central bank is a key part of that stability.

While the risk of interference from the federal government is currently low, particularly with Prime Minister Mark Carney’s credentials as a former central banker, the mood did shift following the pandemic as consumers suffered from high inflation and rising interest rates.

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Politicians of all stripes, including Conservative Leader Pierre Poilievre, former federal NDP Jagmeet Singh, and various provincial premiers publicly attacked the bank on its decisions. More concerning was Chrystia Freeland describing a rate cut as “welcome relief,” given that as federal finance minister at the time, she was responsible for the Bank of Canada.

Politicians should resist the urge to pressure central banks, as their sometimes unpopular decisions are key to keeping inflation low and the economy stable. The federal government should also avoid “mission creep” that tasks the bank with goals such as boosting employment, tackling climate change or inequality. Central banks work best when they can solely focus on managing inflation.

A recent CD Howe report offers other suggestions for protecting the Bank of Canada’s independence that are worth exploring, such as requiring any government directive to the bank to be first discussed in Parliament. With widespread misunderstandings about the bank – a 2023 survey showed that 59 per cent mistakenly believe the federal government has a role in determining interest rates or didn’t know how rates are set – the bank itself has a role to play to educate the public.

An independent central bank is a huge asset. It’s essential in keeping the economy – and the country – strong.