Mark Carney has long been the golden boy of central banking. His deft handling at the Bank of Canada during the recession and his deep knowledge of financial markets helped catapult him across the pond to the Bank of England. But Avery Shenfeld, chief economist at CIBC, has issued a rebuke against Carney’s legacy.
In a new report, Shenfeld writes that Carney took a hands-off approach to the exchange rate after the recession as foreign capital poured into Canada, leading to a “serious overvaluation” of the Canadian dollar. Rate increases in 2010, and somewhat inconsistent messaging on further tightening, caused the loonie to appreciate against the U.S. dollar too. The high Canadian dollar punished manufacturers, led to factory closures, and left the economy overly reliant on home building for growth. “In effect, monetary and exchange rate policy traded off more condos for fewer factories,” he writes. This is a bit of a messy situation for Carney’s successor, Stephen Poloz. “The legacy of earlier plant closures will be with us for years to come,” according to Shenfeld.
The takeaway from the note is that Carney should have intervened to prevent the Canadian dollar from appreciating. This is actually quite a bold suggestion. The Bank of Canada’s mandate is to manage inflation, not the exchange rate. “They long ago realized that the thing they really have the best control over is inflation,” says Chris Ragan, an associate professor of macroeconomics at McGill University. The Bank does take the exchange rate into account when setting policy to some extent, but it’s not the driving factor. (Ragan wrote a paper explaining why this is the case when he was a visiting special adviser at the Bank of Canada.)
Targeting the exchange rate is problematic in that it assumes there is a true or correct value for the Canadian dollar. Instead, its value is determined by market forces, which is why Ragan takes issue with Shenfeld writing the dollar was seriously overvalued. The foreign money that pushed up the dollar after the recession was a legitimate occurrence. “It’s completely appropriate that financial capital would flow into Canada when our fiscal situation is better than in neighbouring countries,” he says. In that way, it doesn’t make sense to think of the exchange rate as either too high or too low. (Mike Moffatt at Western University’s Ivey Business School has also written about why there is no fair value for the loonie.)
So what if Carney had prevented the dollar from appreciating further? He could have done so by removing his tightening bias, cutting rates, printing money, or otherwise intervening in the foreign exchange market. But these moves could have exacerbated the issues the Bank of Canada was seriously concerned about at the time—particularly growing household debt and an overheated housing market. Those concerns haven’t entirely evaporated today, either. Carney didn’t so much trade off condos for factories as address what he saw as the bigger threat to the economy.
He’s been down this road before, too. Carney got some flack in 2012 when NDP leader Thomas Mulcair sounded off about Dutch disease and how the high Canadian dollar was hammering manufacturers. Carney later said in a speech that the exchange rate was only partly responsible for the sector’s decline. “Major forces of globalization and technological change have dispersed manufacturing activity across borders, increasingly concentrating the highest value-added stages of production in advanced economies,” he said. Carney also called attempts to manage the exchange rate “futile.”
“Over time, wages and inflation rise, causing the real exchange rate to appreciate. Non-resource exporters are faced with the same competitiveness challenge as they are today. Moreover, this leads to a sustained period of above-target inflation, which begins to unhinge inflation expectations…. The outcome could be even worse if the Bank cannot quickly re-establish its credibility after betraying earlier commitments to Canadians.”
Carney’s legacy will be a topic of debate for some time. But maybe we can at least agree on his good looks.