Worthwhile Canadian Initiative

Why do central banks have assets?

If you look at the balance sheet of a central bank, you will see it has liabilities (mostly currency) and assets (normally mostly government bonds/bills). Why do central banks have assets? Do they need them?

The wrong answer is that central banks need assets to "back" the value of the currency, and that paper currency would be worthless otherwise. The right answer is: since the government gets all the profits from a central bank anyway, there's no point in giving the government the assets; that owning assets lets the bank reverse course and reduce the money supply if it ever needs to; and it stops the accountants freaking out.

The Conservatives adopt a scorched-earth strategy against the PBO

The idea is simple: if you must retreat, leave nothing behind that could be useful (h/t to Support the OPBO).

Tories unload 4,476 pages of stimulus details: The Harper government has dumped three box-loads of information about its efforts to stimulate Canada's sputtering economy on Parliament's independent budget watchdog.

Kevin Page had asked for more information, complaining that the sketchy data provided up to now made it impossible to tell whether $12-billion in stimulus spending is having any impact on the economy.

But rather than provide an easy-to-analyze spreadsheet listing infrastructure projects and how much money has been spent on each of them to date, the government flooded Page Thursday with 4,476 pages of documents...

[I]t will likely take Mr. Page's office days, if not weeks, to input the information into an electronic database for analysis.

Classy.

What makes a bank a central bank? Asymmetric redeemability and the will to act as one.

Both central banks and commercial banks issue liabilities that function as media of exchange. Why do we say that it is central banks, rather than commercial banks, that determine monetary policy; setting interest rates in the short run, and inflation in the long run? What makes a bank a central bank?

The Globe's Konrad Yakabuski succumbs to the monetary union zombie

And so it continues. I noted on Wednesday that the Globe and Mail's lead editorial on exchange rate policy demonstrated a singular lack of understanding of the economics of exchange rate policy. A particularly astute commenter noted that it was only a question of time before the zombie notion of monetary union started lumbering across the political landscape in search of brains, and it would appear that the Globe's Konrad Yakabuski has succumbed, in the form of a long essay in the Saturday edition.

I don't have a shotgun, so I'll just fisk it:

Economic growth, the universe, and the meaning of life

Notes for a panel discussion in Ottawa on Tuesday evening (details below).

200 years ago, economists made a prediction, and we got it wrong. "Big deal" you might say. But it was a big deal; a much bigger deal than some piddling mistake like failing to predict a global financial crisis. Basically, 200 years ago economists predicted that long run growth was impossible. That's the biggest thing in economics you can be wrong about.

Why can't the Fed just buy yuan?

The title really says it all. And it's not a rhetorical question; I don't know the answer. But if the US is really concerned (H/T Mark Thoma) about the US dollar being too high against China's yuan, and it believes China is "artificially" preventing the yuan from appreciating against the dollar by foreign exchange market intervention, why can't the Fed just intervene in the opposite direction, by buying yuan?

Cheap talk and the exchange rate

Why does the Loonie appreciate when the Bank of Canada tightens monetary policy (relative to what was expected)? And depreciate when the Bank loosens monetary policy (relative to what was expected)?

Before you conclude I've lost it, by asking such an easy question, consider the following weird thought-experiment.

Oil prices in currencies other than the USD

I've received a request to update my irregular series of graphs of movements in oil prices in currencies other than the USD. There's been a certain amount of movement in the oil and forex markets over the past few months, so I'm happy to oblige:

The CAD and the euro have appreciated by about 20% with respect to the USD and the yen since February. And inflation is below target in both Canada and the euro area. So it may not be a coincidence that Willem Buiter's recommendation to the ECB looks a lot like my recommendation to the Bank of Canada.

Economic illiteracy goes viral

It turns out that I may have been unfair to Patricia Croft (chief economist of RBC-whatever-it-is) over here. As Erin Weir points out, she's not the only high-profile professional economist to go from remarking on the relatively small quantity of Canada's official reserves to making the clanging error of concluding that the Bank of Canada's abilities to stop the appreciation of the Canadian dollar are limited.

And now this from the lead editorial in today's Globe and Mail:

Economic policy advice for the Liberals: A conversation with the Cheshire Cat

There are reports that the federal Liberals are going ahead with some sort of conference that is to generate some sort of intellectual infrastructure for an eventual platform for an election, to be held - if things continue to go according to current form - in 2012. So this seems to be as good a time as any to offer Mr Ignatieff and his party some free counsel.

The forex market is dumber than a sack of hammers

I've said it before, and I'm saying it again. The CAD is off by about two cents today:

Canada is no Oz, mate: [W]hat seems to have caught currency markets off guard was the Bank of Canada’s commitment to keeping rates unchanged until at least next June and keeping its expected economic growth rate for 2010 unchanged, at 3 per cent. That is, it downplayed any optimism about the economic recovery because it expects the rising dollar, in the Bank’s words, will “more than fully offset the favourable developments since July.”

“Drawing a parallel with Australia, where a rate hike came earlier than expected, investors have recently been pushing up Canadian short-term yields in anticipation that Canada wouldn’t be far behind,” said Avery Shenfeld, chief economist at CIBC World Markets, in a note. “To those expecting an early rate hike in Canada, the Bank’s message was ‘not so fast.’”

How could this have been a surprise? The Bank has been excruciatingly and tediously clear on this point for months.

Hopefully the last post I'll have to make on the Canada's-housing-market-is-not-the-US-housing-market theme

The National Bank has a summary (pdf) of some numbers comparing how the Canadian housing market has behaved very differently from that in the US:

[W]e compare the housing market correction in Canada with the one that occurred in the United States. The two have absolutely nothing in common. In Canada, the correction got under way much later and lasted nowhere as long. What’s more, it seemed to come about as a consequence of the economic recession; it was not at the source of it as in the United States.

I'm just sayin', I was right.

Disinflation continues, and the case for intervening in the forex markets gets stronger

The September CPI report was published last Friday, and the disinflationary trend of the last few months hasn't yet stopped:

As I noted at the last interest rate announcement,

1. Up until the crash in commodity prices, Canada ran a current account surplus, so an appreciating currency made sense. But now that we're running a current account deficit, it doesn't.
2. The last time the CAD hit parity with the USD, we saw a sharp drop in consumer prices; even the most arithmetically-challenged Canadian consumers revolted when they could see that they were paying higher prices than were being charged in the US. Consumer prices are already below the path that the Bank would like to see.

If we weren't already at the lower bound, I think that we would have expected the Bank to cut interest rates today. I can think of several reasons why the Bank would want to engineer a temporary depreciation in the CAD, and I can't think of a really good reason why it shouldn't.

Why we need more Canadian academic economics bloggers

The economic story du jour is the appreciation of the CAD, and Peter Mansbridge had a panel of economists on The National last Tuesday to discuss it. I get the impression that this is a semi-regular recurring feature. The discussion was - how shall I put it? - unsatisfying.

Stephen Leacock on the benefits of economic stimulus

It has come to the attention of the federal Liberals that ridings who are represented by Conservatives are receiving a disproportionate share of the monies spent under the aegis of the fiscal stimulus:

Ontario was allocated about $1.1 billion in Infrastructure Stimulus Fund money, translating to about $90 for each Ontarian (according to the 2006 census). Mississauga was assigned $46 million (to be matched by the province of Ontario and the city of Mississauga). According to the 2006 census, it means that Mississauga only received $69 per person. The city of Mississauga received 23% less than the provincial average.

It gets worse.  Looking at some cities that are represented by Conservative MPs, the numbers are even more disturbing.  For example, Barrie received $129 per person, Niagara Falls received $200 per person, Cambridge received $170 per person, and Oakville received $279 per person.

There are two possible reactions to this story. One is resigned cynicisism. Another is amused cynicism. And who better than Stephen Leacock to express it?

You could tell from the way John Henry Bagshaw closed the door before he sat down that he was in a pretty serious frame of mind.

"Gentlemen," he said, "the election is a certainty. We're going to have a big fight on our hands and we've got to get ready for it."

"Is it going to be on the tariff?" asked Tompkins. "Yes, gentlemen, I'm afraid it is. The whole thing is going to turn on the tariff question. I wish it were otherwise. I think it madness, but they're bent on it, and we got to fight it on that line. Why they can't fight it merely on the question of graft," continued the old war horse, rising from his seat and walking up and down, "Heaven only knows. I warned them. I appealed to them. I said, fight the thing on graft and we can win easy. Take this constituency,--why not have fought the thing out on whether I spent too much money on the town wharf or the post-office? What better issues could a man want? Let them claim that I am crooked and let me claim that I'm not. Surely that was good enough without dragging in the tariff. But now, gentlemen, tell me about things in the constituency. Is there any talk yet of who is to run?"

Mallory Tompkins lighted up the second of his Prime Minister's cigars and then answered for the group: "Everybody says that Edward Drone is going to run." "Ah!" said the old war horse, and there was joy upon his face, "is he? At last! That's good, that's good--now what platform will he run on?"

"Independent." "Excellent," said Mr. Bagshaw. "Independent, that's fine. On a programme of what?"

"Just simple honesty and public morality."

"Come now," said the member, "that's splendid: that will help enormously. Honesty and public morality! The very thing! If Drone runs and makes a good showing, we win for a certainty. Tompkins, you must lose no time over this. Can't you manage to get some articles in the other papers hinting that at the last election we bribed all the voters in the county, and that we gave out enough contracts to simply pervert the whole constituency. Imply that we poured the public money into this county in bucketsful and that we are bound to do it again."

From Sunshine Sketches of a Little Town.

The Bank of Canada and the dollar in the short and long term

Perhaps the strongest signal that the recession is over is the fact that the appreciation of the CAD is making headlines, just as it did in the last expansion. But since we're operating at the interest rate lower bound, things are a bit trickier this time around.

In the short term, there is a good argument for intervening in the forex markets to slow the appreciation of the CAD. Core inflation is already below the 2% target, and if the CAD starts trading at par with the USD, Canadian retailers will start feeling obliged to cut the prices of goods for which the gap between Canadian and US prices are egregiously large. This will drag inflation even further below the Bank's target.

In the previous expansion, the Bank could deal with this issue by keeping interest rates lower than they would have been if the CAD were not appreciating. But since the Bank can't reduce interest rates below zero, direct intervention is the only remaining instrument. It should be noted that the Bank has made it very clear that this form of quantitative easing is very much on the table, so markets shouldn't be surprised if the Bank decides to use it.

But this is only an argument for the short term, while inflation remains below the 2% target. In the longer term, interest rates will start to rise (some mortgage rates have already started to increase) as we recover from the recession. If our terms of trade continue to improve, the CAD will continue to appreciate, and the Bank will be able to respond by increasing interest rates more slowly.

The September LFS report: Employment and hours worked

Last Friday's LFS release was the best we've seen in a long while. Not only did employment increase for the second month in a row, there was a significant jump in hours worked as well.

Flashbacks to the 1970's: the Bank of Canada and the deficit

Doug Peters and Arthur Donner (names I remember from the 1970s debate over inflation in Canada) have an opinion piece in the Toronto Star on the role of the Bank of Canada in reducing the budget deficit. It starts out fine, but ends in a non-sequitur.

On the role of house prices in the last expansion

I have at various points (here and here) been driven up the wall by lazy journalists who have worked under the assumption that if the US housing market was crashing and burning, then so was Canada's. This premise has led to any number of articles cut-and-pasted from the south with 'US' being replaced by 'Canada'. These pieces were cheap and quick (no research necessary!) and they generated scary headlines. But they were completely stupid and degraded the public's understanding of an important issue.

So it is with a certain amount of satisfaction that I draw attention to a recent Bank of Canada working paper that examines the role of housing prices over the past few business cycles. It turns out that like the US, we have had an episode in which a housing bubble fueled a consumption boom that culminated in a long, painful recession involving significant restructuring. The difference is that our boom-and-bust cycle occurred in the late 1980's and early 1990's:

[R]ising house prices played an important role in consumption growth through the increase in value of housing collateral. This positive effect peaked in late 1986 but continued to have a positive effect on consumption growth until 1989...

Our model suggests that collateral effects contributed as much as 1.0 per cent to yearly consumption growth in 2000 and had a positive effect for most of the remainder of the sample. This contribution is less than in the period from 1986 to 1990, but one simple reason is that the house price increases since 2000 have been more gradual than in the late eighties when they rose to the same level in 3 years rather than 6.

In a previous post, I noted that in many ways, the current US situation resembled what Canada had to deal with in the early 1990's. It would seem that the parallel is even closer than what I thought.

How to kill an afternoon

Do a google street map walking tour of Old Québec.

You could do worse than start at the building where my wife works:

View Larger Map

It's been said before, and I'll say it again: Quebec City is spectacular.