MNI POLICY: Poloz: Outsized Action Needed on Deflationary Risk

By Greg Quinn

     OTTAWA (MNI) - Bank of Canada Governor Stephen Poloz said Thursday an

outsized response to Covid-19 is justified including historic balance sheet

growth aimed at avoiding a deflationary shock.

     Buying up government and corporate debt worth more than 10% of Canada's GDP

was needed as markets threatened to seize up and starve the economy of cash to

sustain activity and relief programs, Poloz said. Cutting interest rates to

about zero does little to aid the economy while most stores are closed, so that

move was aimed more at preparing for a recovery he hopes can be quick and

robust.

     Without the purchases Poloz said "a credit crunch would ensue, and that

would create a significant downdraft in the economy -- in effect, a deflationary

shock. Countering that shock requires providing the demanded liquidity until

tensions ease."

     Comparisons to a depression are unfair because there's no sign of toxic

changes to consumer and business behavior so far, Poloz said in the text of a

private speech to his alma mater, Western University in London, Ontario. 

     The BOC is hardly alone in firing a policy bazooka with the Fed making

historic "Main Street" loans with Treasury backing, while the ECB and BOJ press

further on negative rates and asset purchases. Canadian Prime Minister Justin

Trudeau is also poised for a deficit worth a record 13% of GDP as it rushes cash

to households and business owners stranded by health shutdowns.

     The comments are something of a defense of policies that in June will be

inherited by a new Governor when Poloz's seven-year term expires. Poloz said the

BOC knows at some point the balance of risks will tilt back to record household

debts run up in better times. The remarks are likely one of Poloz's last events

before he leaves and the BOC only announced the closed-door speech a few hours

before it happened. 

     Canada's GDP may shrink by 30% in the first half of this year in a

worst-case scenario the central bank laid out on April 15. The BOC also says

inflation will likely stall this quarter on a drop in energy costs and overall

demand, and a bout of falling prices is possible.

     "At present we face asymmetric risks, as the downside risks are far more

dire than the upside ones," Poloz said. "Crisis conditions argue for vigorous,

even outsized, responses because maintaining confidence is critical to the

recovery; gradualism is unlikely to succeed."

     Here are other highlights from the speech:

*"We heard phrases like "bigger recession than the global financial crisis,"

"biggest recession since World War II" and "biggest recession since the Great

Depression." Such comparisons are unhelpful." 

*"A recession is a dynamic phenomenon: demand declines, firms lay off workers,

confidence declines, people demand even less, more firms lay off workers; in

other words, it is a negative dynamic that takes time and healing to reverse. A

depression is worse; it is deeper and longer and happens because deflation

interacts with debt to create widespread defaults. Neither recessions nor

depressions lend themselves to a simple numerical standard. At this point, there

is no reason to assume that any of these behavioural dynamics will emerge from

the current episode."

*"The situation is much more like a natural disaster than a typical economic

recession -- with policies designed to essentially stop the clock and later

restart it. Economic recoveries from natural disasters are usually quite rapid

and robust."

*"It will be some time before we get back to our normal forecasting environment.

Certainly, we will need to monitor and adjust for any structural damage

judgmentally."

--MNI Ottawa Bureau; +1 613-314-9647; email: greg.quinn@marketnews.com

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