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Published online by Cambridge University Press: 07 November 2014
The purpose of this paper is to analyse and evaluate Canadian post-war monetary policy, in the light of the recurring inflationary pressures to which the economy was subjected. In the evaluation of past events, even the least perceptive critic possesses two great advantages, that is, published statistical data and the revelations of hindsight. When rightly used, hindsight is a valuable guide, but the critic must be careful to distinguish two significant questions: (1) In the light of the relevant contemporary circumstances, what alternatives were available to policy-makers at the time decisions were made? (2) What were the merits or demerits of the policies adopted, when viewed in the light of subsequent events, that is, given the same problem again, would different policies be adopted?
Any analysis, to be useful, must guard against oversimplification and unrealistic abstraction, and it is therefore impossible to evaluate Canadian postwar monetary experience fairly unless the analysis moves beyond the consideration of primarily domestic influences to an adequate recognition of the economic difficulties posed by violent shifts in our balance of payments. The following criticism of specific aspects of Canadian policy does not imply any over-all condemnation, for although we may deplore the damage which inflation has wrought, it must be admitted that its post-war development in this country has been relatively moderate, despite the substantial limitations imposed upon Canadian monetary policy by our open economy.
1 Since any critic should be charitable as well as just, there are few economists who, in the appraisal of Canadian post-war monetary policy, could not benefit by heeding the injunction of John 8:7: “He that is without sin among you, let him first cast a stone.”
2 See Dorrance, G. S., “The Bank of Canada,” in Sayers, R. S. (ed.), Banking in the British Commonwealth (Oxford, 1952), 122.Google Scholar “It is not satisfactory if every significant group of transactions by the central bank leads to a considerable alteration in the prices of the relevant securities. Therefore if the central bank is to engage successfully in open market operations' there must be a well-developed capital market in which the activities of the central bank play only a minor role.”
3 See Economic Controls (Reference Book for the Dominion-Provincial Conference on Reconstruction), 1945, 8.Google Scholar “It is … clear that the curtailment of war contracts covdd be relied upon eventually to break an inflationary boom. The difficulty is that it probably would not prevent an initial inflation of prices. Such an inflation, however short-lived, would be followed by an abrupt deflation which would gravely delay reconversion and produce wide-spread unemployment.”
4 See Clark, W. C., “Canada's Post-War Finance,” Canadian Tax Journal, I, no. 1, Jan.–Feb., 1953, 6 ff.Google Scholar Foreign trade, on which the Canadian economy remained vitally dependent, was completely disorganized and the economies of important customers shattered. In this situation, and fearful of the social and political upheaval which any return to pre-war depressed conditions would entail, the Government committed itself to the objective of a high and stable level of employment and income. Its vigorous preparations toward achieving this end included the introduction of new social services such as family allowances, veterans' benefits, more liberal housing legislation, agricultural price supports, etc. In the monetary-fiscal area, it established the Industrial Development Bank to fill a gap in the capital market, and, in its White Paper, set forth such policies as cyclical budgeting and the maintenance of low interest rates to encourage capital investments. See the White Paper on Employment and Income (Ottawa, 1945), 11, 21.Google Scholar
5 See McIvor, R. Craig, “Canadian War-Time Fiscal Policy, 1939–45,” Canadian Journal of Economics and Political Science, XIV, no. 1, 02, 1948, 62–93.CrossRefGoogle Scholar
6 Thus, for example, the post-war plans of the Government indicated a belief that the Japanese war would continue for some considerable time after the end of the fighting in Europe. The atomic bomb upset this assumption, and there was no “twilight” war period during which the removal of wartime controls could be accomplished on an orderly and gradual basis with the patriotic co-operation of the public. Again, the severe balance-of-payments crisis which emerged in 1947, resulting in part from substantially more severe dislocations in Europe than had been supposed, provided problems of urgent priority, the solution of which involved awkward internal monetary repercussions. In the post-Korean period, the 1950 speculation in the Canadian dollar complicated the problem of dealing quickly with the inflationary upsurge associated with the outbreak of that conflict.
7 Although it is immediately apparent that this period represents something of an historical curiosity, its analysis provides valuable lessons which might usefully be applied to periods of less rapid economic change. The unique features of this period—pent-up domestic demand, unprecedented liquidity, and abnormal export pressures (based on foreign reconstruction and rehabilitation needs, and maintained by extraordinary financial arrangements)—are unlikely to recur, unless at the end of another war (in which event we must leave formulation of post-atomic-war monetary policy to some ad hoc committee).
8 Bank of Canada, Annual Report, 1944, 5. This quotation appears to reject monetary restriction not on grounds of ineffectiveness but rather as being inappropriate to the contemporary economic environment. But when the economic conditions to which the Governor of the Bank referred did in fact develop, monetary restriction continued to be rejected, largely, one suspects, because of awkward repercussions for debt management. This point is discussed later.
9 Ibid. The relative neglect of monetary policy as an instrument of control in the early post-war years was not confined to Canada, being quite evident in the United Kingdom and the United States. This neglect is frequently explained in terms of the “Keynesian” influence. It might be objected that Keynes would not have all but ignored the possibilities of monetary control in the inflationary post-war environment. Some support for this argument may be found in The General Theory: “If we are precluded from making large changes in our present methods, I should agree that to raise the rate of interest during a boom may be, in conceivable circumstances, the lesser evil” (p. 322). However, in reply to this objection, Keynes's main position on this point remains the opposite: “the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms … but in abolishing slumps and thus keeping us permanently in a quasi-boom.” (p. 322)
10 In this first budget designed for peacetime conditions, the Minister of Finance introduced various tax reductions which were calculated to produce a budgetary deficit of some $300 million for the fiscal year 1946–7. See J. L. Ilsley, Budget Speech, June 27, 1946, 28. The actual result was a surplus, in part arising from large “special” receipts which it was not possible to estimate in advance of the order of $375 million. The Minister also stated that “if only immediate economic considerations were involved, one could make a case for temporary higher taxes in order to curb the excess of spending in some directions that is tending to pull prices up” (p. 8).
11 D. C. Abbott, Budget Speech, April 29, 1947, 7. At this time, the Minister planned for a budgetary surplus of some $190 million, a figure which was more than tripled in the event.
12 The Minister emphasized the fact that there was still a great need to prepare for less prosperous times, and that international tensions rendered the Government's financial requirements uncertain, and that in view of its overriding responsibility to influence economic trends, the Government could not justify the release of additional purchasing power through tax reductions. Considering the continuing high level of employment such releases would necessarily intensify inflationary pressures. Moreover, it was necessary to build up an export surplus before the economy could be freed from the emergency import controls necessitated by the 1947 exchange crisis, and this could not be done if additional domestic purchasing power were released.
13 D. C. Abbott, Budget Speech, May 18, 1948, 13. In contrast to the forecast surplus of $489 million, the realized surplus for the fiscal year 1948–9 was $596 million. Underlying each of the budget speeches was the wholly unwarranted assumption that the existence of a budgetary surplus was ipso facto a restrictionist influence. As indicated below, the manner of disposition of the surplus is of fundamental importance. A somewhat different source of misunderstanding as to the economic effects of Canada's post-war fiscal policy arises from undue preoccupation with the Government's “budgetary” position, rather than its “cash” position. The latter is a considerably broader and therefore more relevant concept.
14 Bank of Canada, Annual Report, 1948, 7.Google Scholar
15 See Report of the Royal Commission on Prices (Ottawa, 1949), II, 164. Here are quoted some excerpts from an address by the Minister to the American Academy of Political and Social Sciences, April 1, 1948. See also the Budget Speech, May 18, 1948, 6. Here the Minister admits the existence of the situation which the Governor of the Bank of Canada could not foresee in 1944. “What we need is a slowing down, not a sudden cessation, if the capital development which has been taking place at a pace which has been straining our resources.”
16 Ibid., 165.
17 Events subsequent to this 1946 appreciation were evidently not sufficiently encouraging to persuade the Government that a satisfactory solution to the 1950 exchange problem could be provided by a repetition of this earlier action of appreciating to a new fixed rate.
18 W. C. Clark, “Canada's Post-War Finance,” 14. The Deputy-Minister of Finance referred to the “distortions and rigidities,” “uneconomic production,” and “vested interests” which subsequently arose, in direct contradiction to Canada's official encouragement of more liberal trade policies.
19 The government has three broad exchange rate possibilities: (a) fixed rates (which provide a relatively small degree of autonomy for domestic economic policy); (b) fluctuating rates (which provide much greater domestic autonomy); or (c) some compromise such as “floating” rates, which are permitted to fluctuate without interference between certain limits. It may be fairly assumed that the present Canadian “free” rate is really of the “floating” variety, in the sense that our monetary authorities would not be prepared to accept an unlimited range of fluctuations. Thus, for example, the politically feasible limits to the permitted shifts in the external value of the Canadian dollar might be, say, from $1.10 U.S. to $ .90 U.S. Appreciation is more disturbing politically, since it brings serious repercussions for our major export industries, particularly those whose products must be sold at relatively fixed foreign currency prices. On the other hand, substantial depreciation exerts undesirable inflationary effects under prevailing post-war economic circumstances.
20 See D. C. Abbott, Budget Speech, May 18, 1948, 5. The Minister of Finance contended that the fact that the quantity of money in Canada had not increased since October, 1946, reflected the soundness of the Government's post-war fiscal policy. Particular reference was made to the restrictive effects of the repayment of debt held by the banking system. The Government's cash surplus in 1947 was of record size (about one billion dollars) to which a significant contribution had been made by the repayment of previous advances extended to the Foreign Exchange Control Board, as the reserves of the Board steadily declined. While the use of the Government's cash surplus to repay bank-held debt did in itself exert a restrictionist effect, through the accompanying cancellation or bank deposits, the chartered banks' reserves were not reduced by this operation. The net result, in the absence of central bank action to absorb the excess reserves, was a mere shift in the ownership of chartered bank credit from government to private holders, as the latter category was rapidly expanded.
21 See Bank of Canada Research Memorandum, “General Public Holdings of Certain Liquid Assets,” March, 1953, Table III-A; also Bank of Canada, Annual Report, 1949, 7. In 1945, the banks held approximately $100 million less in non-government securities than in 1939. In 1946 such holdings rose by $114 million, in 1947 by $317 million, and in 1948 by $111 million. In fact, from 1945 to 1947, total chartered bank purchases of provincial, municipal, and corporate securities exceeded the Bank of Canada's estimates of the net new issues of such securities.
22 The Bank of Canada did not “cause” the appearance of premium prices on Canada bonds, and technically, it has not actively supported the market during the post-war period. The important point is that it did not sell in sufficient volume to offset net private buying which was tending to depress yields.
23 See Table I.
24 There had been a similar shift in 1947, implemented largely by non-financial corporations as they began to finance their early programmes of post-war capital expansion. In that year, sales by the life insurance companies (which later became very important) were negligible. The effects of the shift in 1947 were obscured by the Government's huge cash surplus and the fact that the great part of the debt was kept out of the active money supply by a corresponding increase in inactive deposits. In 1948, the disposals of government securities originated largely with the non-corporate public ($332 million) and the life insurance companies ($169 million).
25 Bank of Canada, Annual Report, 1948, 10.Google Scholar
26 Ibid., 7.
27 It is an economic commonplace that central bank operations designed to effect monetary restriction have a more immediate influence than those directed toward expansion, since the banks and the business community cannot be forced to utilize the credit made available when confidence is low. But whereas debt management policy, interest rate policy, and open-market operations are likely to involve no conflicting objectives where the problem is to encourage economic expansion, Canadian post-war monetary experience reveals the unfortunate fact that where inflation is the problem, the conflict between monetary restraint and considerations of debt management may be so serious as to render any effective central bank action impossible.
28 Too often, in discussions of the “responsibility” of the monetary authorities toward the unsophisticated but patriotic investor, the argument turns on the loss which he may suffer as a result of a decline in the money price of the securities. Thus “Congressman Patman … expressed the view that it was ‘a shame and a disgrace’ and a violation of a ‘sacred obligation’ that the Federal Reserve had allowed government bonds to decline below par” ( National City Bank of New York, Monthly Letter, 11, 1951, 131 Google Scholar). Actually, of course, such arguments may stem from lack of understanding, or from a cynical exploitation of the money veil for political purposes. The bondholder can be “done in” more effectively by maintenance of the money price of his securities at the expense of a decline in their real value. Moreover, in this case, the damage is done to all the bondholders, not just to those who want to sell their bonds prior to maturity. In addition to concern for the unsophisticated investor and for maintaining widespread confidence in the bond market, debt management must recognize such considerations as the necessity for refunding, the desirability of minimizing interest rates as an “economy” measure, etc. Not all of these considerations are compatible with one another.
29 The Minister of Finance consistently denied that the Bank of Canada had ever “attempted to maintain an artificial support for government bonds.” See, for example, House of Commons Debates, June 20, 1951, where the Minister further stated that “the Bank of Canada invests in government bonds, but they are purchased at prevailing market prices.” Such disingenuous statements merely obscure the significance of the Bank's open-market operations. In reply to a charge that the Bank had (in 1948) instituted a policy of, in this instance, higher interest rates, the Minister admitted that “the Bank of Canada was simply recognizing what had taken place elsewhere.” Whenever questioned as to the effects exerted by the participation of the Bank of Canada in the bond market, the Minister was invariably evasive.
30 The resident active money supply increased by about $68 million during this time.
31 Immediately following World War II, Canada's foreign trade position was, as already indicated, uncertain, but with the advent of the Korean War, there was every prospect that the organization of defence economies in the United States and elsewhere would require enormous quantities of Canadian raw materials, and strong export markets were assured for many months to come. In the consumers' and capital goods markets, the first inflation had begun with serious shortages but with the prospect of rapidly increasing output, and in fact by 1950, the most important shortages had either been eliminated or reduced to manageable proportions. By contrast, the Korean outbreak was accompanied in Canada by a fear of the renewal of severe wartime shortages. The problem of reconversion and demobilization had been acute in 1946, but with the coming of the post-Korean defence economy, the prospect was for labour shortages rather than possible widespread unemployment. In 1946, there remained in operation the structure of wartime direct economic controls, with the expectation that these could be abandoned by an orderly and gradual process. The Korean situation began with the economy unshackled, and with the Government determined to keep it as untrammelled as possible in spite of the necessity for specific restrictions, notably in allocation of materials. Finally, the liquidity resulting fram war finance had reached its peak in 1946. By 1950, much of this liquidity had been squeezed out through the subsequent expansion of real income and the effect of the first inflation.
32 The depreciation which had been carried out in September, 1949, can be justified only as a competitive adjustment in the face of the much more drastic simultaneous reductions in the value of the pound sterling and many other currencies. On any other grounds, the Canadian depreciation can scarcely be defended. Canada had both a crurent account surplus in 1949 ($187 million) and reasonable stability in her foreign exchange reserves (aloss of $11 million between the end of 1948 and August, 1949). In contrast, the pressure on sterling reserves was tremendous.
33 See Clark, W. C., “Canada's Post-War Finance,” 15.Google Scholar
34 Since the end of the war, our foreign exchange reserve position has been dominated by the effects of short-term capital movements. Under fixed exchange rates, such movements exerted a destabilizing influence, in the belief that the fixed rate could not be held. With the free or floating rate since 1950, the short-term capital movements have worked in our interest, as a stabilizing force, and as a means of simplifying the problem of financing exchange reserves.
35 The failure of this policy to accomplish a tightening of credit has already been noted above.
36 The importance for monetary control of the maintenance of substantial government deposits in the chartered banks must be noted. Shifts in deposits from the chartered banks to the Bank of Canada can have as important restrictionist effects as open-market operations, without any direct effect on the securities markets. This device might have been employed more vigorously in 1947.
37 This reversal of policy was accompanied by more restrictive fiscal measures in which taxes were increased, and in such a manner as to discourage the consumption of commodifies for which materials were likely to be in short supply.
38 The market, unaccustomed to this sort of behaviour by the Bank, did not appear to have appreciated what was occurring. In November, interest rates did weaken, but the magic of “par” was still strong, and at the end of December the longest Victory Loan was quoted to yield 2.97 per cent.
39 In the 1950 Annual Report of the Bank of Canada, the Governor referred to an increase of $270 million in loans (excluding grain loans) during the last quarter of that year, as compared to $17 million for the same quarter of 1949. In addition, during January–February, 1951, there occurred a further increase of $71 million in total Canadian loans, as compared to a decline of $21 million for the comparable 1950 period. At the end of 1950, the cash ratio of the chartered banks had been reduced to 10.1 per cent. The Banks had no “excess” reserves to utilize, although these might be obtained by the sale of bonds.
40 Bank of Canada, Annual Report, 1951, 9.Google Scholar The Governor of the Bank of Canada noted that: “In view of the degree of inflationary pressure and the strength of the demand for more credit, the Bank felt that the situation called for action over and above further tightening of the chartered banks' cash reserve position. Meetings with representatives of the chartered banks during February 1951 to discuss the situation found the banks in agreement with the suggestion that further expansion of total bank credit was undesirable under existing conditions.”
41 In his 1951 Budget Speech, the Minister of Finance stressed the “voluntary” cooperation of the banking system in the public interest. In the 1951 Annual Report of the Bank of Canada, the Governor observed that “It was evident that there was a desire on the part of banks to maintain a higher cash ratio than they had during the first half of 1951.” It is true that in the second half of 1951 the cash reserves of the chartered banks rose by some $124 million, but this was largely a result of a decline in the Bank of Canada's “Other Deposits” which was not offset elsewhere in the Bank's accounts. With the credit ceiling effective, it would appear that the cash ratios of the chartered banks would inevitably rise, regardless of their wishes in the matter.
42 See House of Commons Debates, Nov. 19, 1951, p. 1131: “it is not the policy of the government, or of the Bank of Canada, to cause a fall—or, for that matter, a rise—in the market price of government bonds.” It was further pointed out that between issue and maturity, the price of a marketable bond “is a reflection of varying conditions which affect the desire of bondholders to sell and of other persons to buy.” The validity of the first quotation rests upon an apparently calculated ambiguity as to the interpretation of the Bank's “causal” influence in the market. But however interpreted, it represents a substantial change in the Government's thinking since the appearance of the 1945 White Paper, in which the avowed purpose of monetary policy was the continuation of low interest rates to encourage investment in productive capital, thereby contributing to employment.
43 Bank of Canada, Annual Report, 1951, 12.Google Scholar
44 During 1951, the Bank of Canada added $249 million to its holdings of government debt, and the government accounts added $162 million. Retirements amounted to some $592 million.
45 Like most ad hoc measures, the credit ceiling had severe limitations. In this connection, see Timlin, Mabel F., “Recent Developments in Canadian Monetary Policy,” American Economic Review, XLIII, no. 3, 05, 1953, 46–7.Google Scholar Here it is observed that a credit ceiling is likely to be concocted “only after a trend has been well established and when it may be difficult to arrest. Moreover, political pressures may dictate the removal of these substitute arrangements at a relatively early date.” It is a singular coincidence that the credit ceiling was imposed in February, 1951, at about the time that wholesale prices in the United States reached their post-Korean peak.
46 See Bank of Canada, Statistical Summary, 09, 1952, 145–6.Google Scholar Changes in the insurance companies' net holdings of direct and guaranteed Canadian government debt were as follows: 1946, +$107 million; 1947, —$12 million; 1948, —$169 million; 1949, —$171 million; 1950, —$185 million; 1951, —$149 million. The insurance companies' sales in 1948 and 1949 were readily absorbed by the monetary system since the chartered banks were net purchasers ($311 million and $153 million). In 1950 and 1951, the banks were net sellers, and the insurance companies provided an additional large and persistent supply of bonds to the market.
47 In so far as the Bank's reluctance to make effective use of open-market operations in curbing credit has been based on adverse repercussions upon debt management, further support might be forthcoming for the attempt to segregate individual and institutional investors. If the unsophisticated “individual” bond purchaser were provided with a non-marketable bond, free from adverse capital fluctuations, the stultifying influence of “moral” commitments to bondholders might be eliminated, since presumably the corporate investors will not expect immunity from the possibility of adverse fluctuations in bond prices before maturity.
An objection to this arrangement is that as the proportion of the national debt held in the form of non-marketable bonds increases (at the end of 1951, $1.2 billion of the estimated $5.1 billion in the hands of the resident non-corporate sector was non-marketable), the potential inflationary danger becomes more serious. The monetization of this kind of debt is not subject to any form of direct control (except repudiation) other than “moral suasion.” In any period of a widespread flight from securities to money, the monetization of non-marketable debt would present serious problems.
In this connection, it is our opinion that the increase from $2000 to $5000 in the maximum holding permitted in any one name is mistaken generosity. The Canada Savings Bond may legitimately provide an emergency reserve for the small investor, but holdings of any series in excess of $2000, presumably for long-term purposes, should surely be subject to ordinary market fluctuations.
48 Timlin, “Recent Developments in Canadian Monetary Policy,” 52. No indication is offered here of the anticipated process by which the anti-inflationary effects of a restrictive monetary policy would become effective, that is, whether by operating directly on the general price level through the immediate effects upon the active money supply or indirectly via the consequences of rising interest rates. Post-war experience suggests that the latter might have been more important than mere changes in the active money supply. As against the inequities stemming from the two periods of major inflation, the lasting benefit has been the substantial increase in Canadian productive capacity associated with the unprecedented level of post-war capital investment. Against this gain must be set the possibility of serious cyclical disturbances arising from the stickiness of the inflated post-war costs of production. One might argue (as Miss Timlin undoubtedly would) that the same capital expansion could have been obtained at lower price levels; if this premise is granted, the remaining grounds for a retrospective defence of actual monetary policy to late 1950 is severely limited.
49 An approach to easing the shackles imposed by considerations of debt management is outlined in footnote 47.
50 This device has been frequently employed by the Federal Reserve in the United States, and provides a means of immobilizing reserves without incurring the same movements in security prices which accompany open-market activity, and which present such awkward problems of debt management.
51 In January, 1954, the Bank of Canada recorded an advance of $10 million to the Royal Bank of Canada. This rare occurrence was of particular interest because of the , explanation provided by the borrower in its 1953 Annual Report: “If the chartered banks become accustomed to temporary borrowing from the Bank of Canada to take care of temporary adverse swings in their cash position they will also be more willing to purchase treasury bills and other short-term securities when they experience a temporarily favorable swing in their cash position. In doing so, the chartered banks will tend to broaden the market for these securities.” It is thus conceivable that the break-down of the unfortunate tradition against borrowing may be furthered by the chartered banks' interest in broadening the Canadian short-term money market.