We need central bank independence

The head office of the Bank of Canada in Ottawa. (Credit: Adam Huras/Brunswick News files)

Donald Trump provides daily case studies for democratic nations on how not to govern. His insatiable demand to be totally in control, unconstrained by a strong cabinet, the Constitution or law, has eroded state capacity and sent American exceptionalism into dizzying decline.

To its considerable credit, one institution that has not bent to Trump’s will is the U.S. Federal Reserve Board, led by its Chairman Jerome Powell. The Fed is not an executive agency, but an institution created by Congress in 1913. Independence from political influence is widely regarded as essential for the Fed to fulfill its dual mandate of price stability and maximum employment. Some past presidents have attempted to jaw-bone the Fed to lower interest rates, notably Lyndon Johnson and Richard Nixon, but none has launched such vicious attacks on the institution and its chair as Trump or lobbied so publicly for ultra-low interest rates.

Central bank independence matters, not just in the U.S., but everywhere. Former Fed chairs Ben Bernanke and Janet Yellen argued recently in The New York Times that “the ability of the central bank to act independently is essential for its effective stewardship of the economy.” They went on to add that a central bank’s credibility is an important national asset — hard to acquire but easy to squander.

Those views were echoed by Prof. Anil Kashyap of the Chicago Booth Business School and legendary hedge fund manager and GOP mega-donor Kenneth Griffin in a recent Wall Street Journal op-ed: “The president’s strategy of publicly criticizing the Fed, suggesting the dismissal of governors, and pressuring the central bank to adopt a more permissive stance toward inflation carries steep costs. These actions raise inflation expectations, increase market risk premiums, and weaken investor confidence in U.S. institutions.”

That President Trump gets to appoint a new Fed chair next year increases risk in the American economy and will have spillover effects for the rest of the world.

What should Canada do?

First, our own politicians should dial down the rhetoric. The independence of our central bank was tested back in the late 1950s and early 1960s with conflict between prime minister John Diefenbaker and Bank of Canada governor James Coyne. It was the greatest institutional crisis the Bank ever faced and ultimately led to Coyne’s resignation. In recent years some federal party leaders and provincial premiers have criticized the Bank in language dismissive of its independence. While constructive criticism is healthy, and the Governor appears before Parliamentary committees and holds press conferences on a regular basis to explain monetary policy decisions, some of their salvos have ranged from grandstanding to threatening to fire the governor. Their words have been everything from dewy-eyed to dumb to dangerous.

Second, the current Bank of Canada five-year policy agreement, which sets the inflation target framework, ends Dec. 31, 2026. As the government and the Bank prepare for its renewal, the government should emphasize at the outset that it will not tamper with the Bank’s independence in any way. An all-party parliamentary resolution to this effect would underscore the point — or at least force all parties to declare themselves.

Third, the Bank should continue to show humility and acknowledge that inflation is hard on Canadians, and it should recognize its own role in letting inflation get out of control in 2021-2022.

Finally, the mandate update should focus on the inflation target range and midpoint that work best for Canadians over the second half of this decade. It should avoid other objectives that have more to do with fiscal policy, muddy the waters, lead to government second-guessing and can ultimately undermine the Bank’s independence. It should reinforce the role of the central bank in making sure payments systems are efficient and risk is well managed, especially as the Trump administration ramps up the use of crypto currency in payment systems.

In an increasingly volatile world, a strong, independent Bank of Canada will help ensure we can navigate the inevitable economic shoals while keeping borrowing costs and inflation low for Canadians.

Kevin Lynch, former clerk of the Privy Council, was vice chair of BMO Financial Group. Paul Deegan, who was an executive at BMO and CN and served in the Clinton White House, is CEO of Deegan Public Strategies.