The Bank of Canada can prevent a recession from becoming a depression

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Bank of Canada Toronto Building in 2018. Image: Can Pac Swire/Flickr

The Bank of Canada has a new governor, Tiff Macklem. What it needs is a new policy direction.

Official bank policy is "inflation targeting," using monetary policy to keep inflation between one and three per cent.

Amid a health crisis, Canada faces a new challenge: debt deflation.

The rapid accumulation of debt by governments, businesses and individuals as a result of business closures, physical distancing and "stay at home" orders has amplified the risk of a recessionary crisis caused by attempts to pay down debt. 

In the transition out of the economic shutdown, companies, individuals, governments and other public agencies will be uncomfortable living with the increased debt loads, and be reluctant to take on new debt. 

Debt deflation occurs when debt repayments displace current expenditures, shrinking the economy and acting like a brake on renewed economic growth.

Businesses contribute to debt deflation by reducing expenditures on salaries, goods and services, research, and capital improvements. Governments contribute by not filling vacant positions, and postponing capital projects. Individuals add to it as people make paying down mortgages, bank loans and credit card debt the priority.

When economic agents of all sorts postpone or curtail current expenditures in order to pay down debt, the effect is a cumulative decline in domestic output and revenue.

If debt deflation takes hold, a recession becomes a depression. 

A former senior governor, Macklem gained kudos for his role in assuring banks could overcome the credit freeze that accompanied the financial crisis of 2008. It was presumably why he was appointed by Justin Trudeau, and the current senior deputy governor Carolyn Wilkins was passed over, despite the prime minister's professed feminism.

In 2020, the great risk is not banks being short of cash on hand -- it is businesses, households and individuals going bankrupt.

As Mike Moffat shows, the economic fallout from closures of the hospitality, tourism, education, recreations, sports, entertainments, events management and other economic sectors reveals that women are disproportionately affected by job losses and income reductions. As well, women pick up the responsibilities of home-schooling children and elder care.

The approach of the Canadian government to recovery from the self-imposed economic collapse needs to be a gendered analysis.

In these unusual times, Canada and other economies face a solvency crisis as borrowers are unable to pay their debts, not just a shortage of liquid funds as in the 2008 crisis. 

To ease debt deflation, the governor is going to have to force the banks to relax treatment of borrowers, and forgive bad loans.

Debt writeoffs are inevitable. Bad debts need to lead to banks taking loan losses and reducing profits, not just clients going under. 

In Canada, governments traditionally see the chartered banks as the source of economic wisdom. Now Finance Minister Bill Morneau must enlist the chartered banks in a defence of those facing bankruptcy through no fault of their own. These favoured clients need not include companies using tax havens, or buying back their own stock, or refusing to reduce dividends payments. 

A starting point would be to get the finance minister to order banks to stop charging interest on credit card debt until further notice.

As the lender of last resort, the Bank of Canada has a duty to provide liquidity to the banking system. Now, to prevent economic chaos, it must ensure that bankers do not drive their clients to the wall.  

As the economy transitions out of a lock down, the Bank of Canada can keep interest rates low.

Growth in debt levels for individuals, and companies, as well as governments and other public agencies is determined by the rate of interest. Interest rates charged by chartered banks reflect the central bank overnight lending rate.

The current Bank of Canada rate is 0.25 per cent. 

The economy is shrinking, so economic growth is lower than interest payments on the debt. Debt burdens are going to grow for all those who do not see their revenues or incomes grow by more than 0.25 per cent. That will include the federal government.

At the point when the economy grows faster than the debt, the amount of debt as a proportion of economic output (GDP) will decline. There is a need to encourage growth for that reason.

The Bank of Canada is owned by the government, but has secured its independence from direction by either the finance minister or the cabinet. 

Conventional wisdom suggests that what the Bank of Canada does depends on what it decides to do itself. 

In order to avoid debt deflation, the Bank of Canada and the Department of Finance are going to have to work closely together. 

Government spending needs to keep increasing -- no attempt should be made to reduce federal debt loads through austerity.

The role of the Bank of Canada in a deflationary crisis is to encourage debt payment holidays, and lead debt forgiveness efforts such as forgiving student loans. Easing mortgage and credit card debt is an effective way to promote growth.

The new policy direction for monetary policy should be to target deflation (not price inflation), reduce recessionary pressures and prevent a depression.

Duncan Cameron is president emeritus of and writes a weekly column on politics and current affairs.

Image: Can Pac Swire/Flickr

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