November 19, 2019 – The Bank of Canada’s current mandate should not be expanded to include financial stability, says a new report from the C.D. Howe Institute.
In “The Bank of Canada and Financial Stability: A New Mandate?,” authors Michael D. Bordo and Pierre L. Siklos marshal historical and empirical evidence to make the case that the Bank of Canada should not confuse the public by adding the burden of meeting a goal—financial stability—it cannot reasonably achieve on its own.
Although calls to increase the burdens placed on central banks have become more widespread at the international level in recent years, policymakers need to be made aware that such views can be based on misguided assumptions. These include assuming all financial crises are the same; that we know the size, timing and spillovers from financial crises; and that financial stability policy is capable of being forward-looking.
Financial crises emerge from a wide variety of sources, often leading policymakers to overreact, write Bordo and Siklos. In an effort to prevent such events from ever being repeated, policymakers are looking to the central bank to create solutions. Bordo and Siklos show, however, that the varied nature of past financial crises poses challenges.
“Unless the next financial crisis is very similar to the last one, it is not clear how current policy instruments or regulations in place today will prevent a recurrence,” says Siklos. “Efforts should be maintained to forestall such events, but the most appropriate strategy need not consist of an expansion of the Bank of Canada’s current mandate.”
Bordo and Siklos illustrate the challenge of adding an explicit financial stability mandate by contrasting the occurrence of business and financial cycles over time. Business cycles are used by central banks to gauge the appropriateness of the stance of monetary policy and whether there is a need to tighten or loosen it to ensure that inflation is kept under control while preventing large swings in output and inflation. In contrast, the financial cycle describes self-reinforcing interactions between risk-taking and financing constraints.
“With the relationship between business cycles and financial cycles being extremely weak, it would be difficult for the Bank of Canada to manage both price stability and financial stability,” says Bordo.
The Bank of Canada’s focus on price stability should not change, conclude Bordo and Siklos, but it should be provided with greater latitude to become more forward-looking in highlighting potential threats, both domestic and foreign, to financial stability. The Bank should also be encouraged to highlight how partner agencies can pre-empt a future crisis, all while striving to maintain inflation within the target range.
For more information contact: Michael D. Bordo, Board of Governors Professor of Economics and Distinguished Professor of Economics at Rutgers University; Pierre L. Siklos, Professor of Economics at Wilfrid Laurier University; or Nancy Schlömer, Communications Officer, C.D. Howe Institute, phone 416-865-1904 ext. 0247, email: nschlomer@cdhowe.org.
The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada's most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.