First, here's the full picture of the Bank of Canada's finances for 2021 before all the fun started.
The Bank earns revenue from interest earnings on bonds that it holds. Expenses are (1) normal stuff, staff, etc., and (2) interest expenses, which I'll explain next.
Commercial banks hold much of their reserves at the central bank. They earn interest on these deposits. Recently those holdings have grown significantly as a result of quantitative easing during the pandemic. Now ~$200 billion earn interest at 3.75%.
That has dramatically increased interest payments to commercial banks. I estimate that sometime this summer, interest expenses exceeded total Bank of Canada revenues. The Q3 books released today was the first time this has been confirmed. bankofcanada.ca/wp-content/upl…
This is unique. Normally when interest rates rise so does Bank revenues/profits (graph shows all years in Bank history). But today its bonds were acquired at low rates and aren't being replaced by newer higher earning ones as it shrinks its balance sheet. But expenses are rising.
Fun historical aside, paying interest on deposits at the Bank of Canada is a modern thing. At first, it was not allowed to. Here's the original Act. Things changed in the late 1990s for reasons we don't need to get into now.
Loses at the central bank is also new for Canada. Typically, surpluses typically go to the government as a remittance.* That will no longer be the case.
* Just accounting. The Bank of Canada is consolidated within the federal govt books like all enterprise crown corps.
How does the Bank of Canada "cover" this loss? Well, in Q3 it had an outstanding amount owing to the government. An accounts payable, if you will. So, it just shrunk that.
In the future, it will need to do something else. The U.S. Federal Reserve is booking its losses in a "deferred account", which is just a way of saying it'll give the Treasury less in the future to make up for the losses today.
The govt here hasn't decided what to do.
Should taxpayers be concerned? As a crown corp, losses will negative affect the federal budget. But we should think of this as no different than the government's debt service costs. Higher interest rates increase those costs.
In effect, QE is like the government (from a consolidated perspective) issuing a bunch of short-term (think: overnight) debt to fund the redemption of long-term debt. This makes debt service costs more sensitive to changes interest rates.
It's just that we account for it differently. The Bank pays interest on deposits, which is recorded as an expense on its books not as interest expenses to the federal government. But that's really all it is.
So yes, there are implications for the federal budget -- but it isn't a novel challenge and no different than the effect that rising interest rates has.
Also, critically, the Bank of Canada is not a commercial bank. Losses don't affect its ability to operate, and there really isn't such a thing as solvency here. Their goal is also not to generate profit, but to conduct monetary policy.
The federal deficit this year is projected to fall to $36b from Budget 2022's projection of $53b. Here's the breakdown of what caused the change. #cdnecon#cdnpoli
Hard to be precise, but it looks like the overwhelming majority of the increase in income taxes is due to high oil prices.
Corp income taxes up nearly $23b. That's almost two-thirds of the change. Oil & gas, mining, petroleum products dominate the increase in corp profits.
Interestingly, total GST revenues are projected to come in lower than Budget 2022 expected. I anticipated an increase due to inflation (higher prices --> higher GST payments). Likely due to the slowdown in economic growth currently happening (and reflected in the projections).
Inflation has many concerned, and it's a complex issue. So I'm happy to share some results of work with my colleague, Prof. Sonja Chen: papers.ssrn.com/sol3/papers.cf… Not yet peer-reviewed, but there's some interesting results I'll preview here. 🧵 #cdnecon#cdnpoli
First, it's important to appreciate that rising inflation is accounted for by a few specific items. Had energy and shelter prices, for example, not increased then overall inflation would have been 4.1% in July rather than 7.8%.
More interesting is the spillover effect of energy prices on other goods and services. We find roughly one-quarter of items move up and down strongly with oil prices. And those items account for 60% of the non-energy inflation we're seeing.
Some in AB's Govt are saying the surplus is due to "fiscal discipline".
All govts will spin, of course. That's what politicians do. But this claim is way off. 🧵
Quick note to start: I'm interpreting the claim of "fiscal discipline" as deliberately, and in some case explicitly, setting up a contrast w/ former govt.
Obviously if we spent 500b digging holes and filling them in again we'd have a deficit; so "discipline" has a role.
So the question is whether the current government's spending plans, which were indeed lower than the previous government's, is the reason for the surplus.
Today's high inflation is regressive. This point has been made by many, but I thought some numbers might help. 🧵 #cdnecon
I estimate the effect of price increases on household disposable incomes here 👇. The high rates for May (reported today) are like a nearly 10 percent reduction in the disposable incomes of the lowest income families. Let that sink in a moment.
This is not because lower-income households buy more items w/ big price increases. The reverse is true (owned accommodation, for example).
Here's a set of estimates of the inflation rate for different types of households based only on differences in products purchased.
Inflation pressures are broad-based, to be absolutely clear, but this is worth noting: if shelter and energy prices remained flat since last year, I estimate headline inflation would have been 3.2% in May instead of 7.7%. #cdnecon
This is not to deny the financial pressures that price increases create. But it shows that the biggest pressures are narrowly concentrated. This may matter for policy makers trying to figure out where to direct efforts and to understand what is going on.
Also worth noting, this doesn't account for the spillover effects of rising energy prices on goods and services throughout the economy. This is hard to estimate, but my best attempt is that this may add another 1-1.5 points on top of energy's direct 2.5 point contribution in May.
Price increases are also broad based across many product categories. Approximately two in three items within the CPI saw price increases above 3%.
What's behind the acceleration of inflation? Two years ago, the rate was close to 2% (near the target). The increase to 5% is due to just a few items: groceries, gasoline, home depreciation, fuel. Here's an illustration.