MNI POLICY: Poloz Says QE Needed to Fight Deflation "Crater"

By Greg Quinn

     OTTAWA (MNI) - Governor Stephen Poloz said Monday the risk of a "giant

deflationary crater" justifies unprecedented asset purchases and the Bank of of

Canada may go further if record government deficits add new strains in financial

markets amid Covid-19.

     The BOC learned to "eschew gradualism" following the 2008-09 financial

crisis and Poloz repeated his quip that a firefighter is never criticized for

using too much water. Monetary policy including government debt purchases is

playing more of a supporting role to fiscal action that works better in a

situation where people can't spend because many stores are still closed.

     "We recognize that near-term cash demands from governments may put renewed

strain on financial markets, but we are prepared for that possibility," Poloz

said in a lecture, in one of his last events before he retires on June 2 and

Tiff Macklem takes the helm. 

     The BOC is buying at least CAD5 billion of federal government bonds a week

until a solid recovery emerges, taking some strain off Prime Minister Justin

Trudeau's deficit that's tracking towards 15% of GDP. The Bank cut interest

rates to 0.25% last month and has grown its balance sheet to CAD442 billion to

keep credit lines flowing as Covid-19 forced business shutdowns and people to

stay at home. 

     Poloz made one of the clearest statements yet about the risk that a plunge

in global demand could turn from a narrow drop in energy costs into broad

deflation, saying it justified "extreme" policies. "Our dominant concern was

with the downside risk and the possibility that deflation could emerge," he

said. The 12-month CPI has fallen for the first time in a decade as energy

prices and car sales plunged.

     --NO TRADEOFFS

     "The downside risks were sufficiently dire that there were no relevant

trade-offs for monetary policy-makers to consider. Picture the pandemic creating

a giant deflationary crater in the middle of the economy; it takes what looks

like inflationary policies to offset it," Poloz said.

     "Obviously, the economy will need significant monetary stimulus in the

rebuilding stage," Poloz said. 

     Policymakers must take advantage of the flexibility they have on how fast

to return inflation to around the BOC's 2% target, especially as the economy

restarts, he said. The nature of the shock means they must use judgment and rely

less on economic models that struggle to capture the pandemic's impact on the

economy.

     "It does not make sense to think a single, optimal path for our policy

interest rate will be consistent with achieving our inflation target," he said. 

     --RISING DEBTS

     Covid-19 will lead to a jump in government debt, Poloz said, focusing less

on the record consumer debt burdens that put the economy in greater danger over

the last decade. The central bank should however put weight on the tradeoff

between boosting near-term growth and the potential for another crisis later, he

said.

     Still declining to call the asset purchases QE, Poloz said the policy will

work better if it remains connected to the BOC's inflation target at a time when

monetary independence could be under question. The purchases can be scaled back

as the economy rebuilds, he said. 

     Other highlights:

-"Central banks can use some tools to restore market functioning in turbulent

times and also to stimulate macroeconomic activity when financial markets are

not disrupted. The same actions that we have taken to improve market functioning

will become an important source of economic stimulus down the road."

-"The level of coordination between the Bank of Canada and the fiscal authority

has been unusually high. This has even included unprecedented joint

Governor-Finance Minister press conferences, a show of strength intended to

buttress confidence in the economy. Throughout, the importance of the

independence of the central bank has been underscored by both parties. It is

well understood that the Bank's ability to lend without limit must be backed up

by the inflation target to anchor inflation expectations."

-"The actions taken to counter the effects of the pandemic will clearly lead to

higher indebtedness, for governments in particular. Getting the economy back

onto its growth track -- which is what is required if we are to hit our

inflation target -- is the surest means of servicing those debts over time."

-On avoiding forward guidance: "It does not reduce the total amount of

uncertainty. Uncertainty is simply shifted onto the central bank's shoulders...

they set up a one-way bet in markets... Market prices cease acting as a check

for our own projections... The central bank should not try to force alignment of

market views with our own. Instead, we should be helping markets understand the

thinking behind our policy decisions."

-"Through this episode, the lessons of 2008-09 led the Bank to eschew

gradualism. Instead, the unconventional policy tools were deployed across the

board, and aggressively so. In one press conference I was asked if perhaps we

were overreacting. I responded that a firefighter has never been criticized for

using too much water."

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

[TOPICS: M$C$$$]