We at the CTF are often emailed questions about the Bank of Canada.  Most commonly we are sent links to little girls on youtube talking about the Bank of Canada, to the Michael Journal or videos of retired teachers explaining why the Bank of Canada should simply print money to pay off the National Debt, rather than the government borrowing money from commercial banks...

Should they?  Should the federal and provincial government order the Bank of Canada to print money to pay off our debt?

We asked an expert to help answer a couple of questions.

Why doesn’t the Bank of Canada just print money to pay off our National Debt?

Dr. Ron Kneebone, Professor of Economics at the University of Calgary answers:

The Bank of Canada is owned by the Government of Canada so that any income earned by the Bank is handed over to the Government.  This sets up a really cool idea that some people are advocating.

It works like this: the government regularly prints Government of Canada bonds and sells them to people like you and me.  Canada Savings Bonds are one type of bond the government sells but there are others.  Selling bonds is one way the government raises revenue.  The other way, of course, is to tax us.  But when taxes are insufficient, the government can sell us Government of Canada bonds and get revenue that way.

Although this sounds like an attractive alternative to raising taxes on cranky taxpayers, the government still faces a problem; it is on the hook to pay us interest on those bonds.  The more bonds the government sells – that is, the bigger is its debt – the more it must pay in interest.  The amount of interest that the federal government pays in interest is quite large.  In 2011, they spent $31 billion.  Provincial governments also sell bonds and so they also pay a lot in interest; about $23 billion in 2011 in total.  In 1995, when interest rates and the pile of government debt were both higher, all governments in Canada were paying about $78 billion in interest payments annually.  To put that into perspective, in that same year governments spent about $53 billion on health care.

The Bank of Canada can also buy these bonds.  When it does, it pays for them by printing money.  (The Bank does not literally print currency, but by purchasing bonds they put in motion things that cause the money supply to grow.  Don’t ask or I will tell you how.)  Like you and me, the Bank of Canada receives interest on the bonds it buys.  BUT THE BANK IS OWNED BY THE GOVERNMENT AND SO RETURNS THE INTEREST TO THE GOVERNMENT.  Sorry for shouting but that is the exciting bit.  It means that if the government sells its bonds to the Bank of Canada, it is as though the government pays no interest on that debt.  This is better than raising taxes on cranky taxpayers.  If only we can get the Bank of Canada to buy these bonds we could save ourselves the $54 billion in interest payments.  It is free money!

This is not a new idea.  Governments have been using this method to raise revenue for a long time.  During the 1920s, the governments of Germany, Austria, Poland and Hungary all required their central banks purchase government bonds.  In each case the central bank paid for these bonds by printing money.  In each case the result was what is known as “hyperinflation;” rates of inflation exceeding 50% per month.  If you wonder why in 2012 the German government was so hesitant to allow the European Central Bank to buy up Greek debt, you need only remember Germany’s history with hyperinflation.

Lest you think this is ancient history, this method for raising revenue has been tried more recently.  But the results have been the same.  During the period 1971 to 1973 inflation reached levels of 500% per year in Chile.  Just over a decade later, in 1985, the rate of inflation exceeded 11,000% per year in Bolivia.  Since 2000 the government of Zimbabwe has printed trillions of Zimbabwe dollars resulting in rates of inflation hitting 98% per day; the equivalent of over 35,000% per year.

Oh.  Maybe this is not such a good idea after all.  These experiences are the reason that good central banks, like the Bank of Canada, refuse to play this game of buying inappropriate amounts of government debt.  The Bank of Canada understands that its mandate is to maintain a low rate of inflation and this requires that it keep tight reins on the amount of money in the economy.

Those who advocate the “no interest loans solution” emphasize that the Bank of Canada has, in the past, purchased government debt without serious consequences.  Are they right?

They are correct that the Bank of Canada does buy government debt.  It does so as part of its mandate to regulate the supply of money in the economy.  Buying federal government bonds – paid for by printing money – is one tool the Bank uses to fulfill its inflation mandate.  The Bank, however, is very careful to ensure it does not buy so much as to threaten its low inflation target and it has never purchased debt simply to relieve the federal government with the need to pay interest.  Those advocating the “no interest loans solution” are less correct about the suggestion that the purchase of government debt has never had unfavourable consequences.  During the 1970s the Bank of Canada relied much more heavily than it does now on purchasing federal bonds as a way of regulating the money supply.  This turned out to be a less successful policy than hoped.  Those of a certain age will recall inflation rates exceeding 10% per year and the implementation of wage and price controls in an effort to slow inflation.  That earlier policy has been replaced with one that relies much less on purchase of government debt.

Maybe that has not convinced you.  If not, let me try another tack.  No one likes to pay taxes.  So when we pay taxes we demand government prove to us that we are getting good value for our money.  We vote them out if they propose low-return public projects and vote them in if they convince us their spending proposals provide us with good value for our tax dollars.  This disciplines governments to think hard before coming hat in hand to cranky taxpayers.  This is how it should be.  The idea of forcing the Bank of Canada to purchase government debt to give the government access to interest free borrowing is an invitation to fiscal profligacy.  Why would taxpayers ever want to do such a thing?

So, bottom line, responsible central banks do not purchase government debt in order to relieve governments of the need to pay interest on their debt.  Canada is not Zimbabwe and that, at least when it comes to inflation, is a very good thing.

Ron Kneebone is a Professor of Economics and Director of Economic & Social Policy in The School of Public Policy, both at the University of Calgary.  His research interests are mainly in the areas of the macroeconomic aspects of public finances and fiscal federalism.  His published research has dealt with issues pertaining to government budget financing in a federal state, the political economy of government deficit and debt reduction, the history of government fiscal and monetary relations in Canada and the characteristics of Canadian federal, provincial and municipal fiscal policy choices.  Professor Kneebone is a co-author of two undergraduate textbooks in economics; a best-selling economics principles text with co-authors Gregory Mankiw and Ken McKenzie and an intermediate level text with co-authors Andrew Abel, Ben Bernanke, and Dean Croushore.  For joint work with Ken McKenzie he was awarded the Doug Purvis Memorial Prize for the best published work in Canadian public policy in 1999.  From 2002-2006, Professor Kneebone was an associate editor of Canadian Public Policy, Canada's foremost journal examining economic and social policy.  An eight-time winner of a Superior Teaching Award in the Department of Economics he was also awarded the Faculty of Social Sciences Distinguished Teacher Award in 1997 and again in 2003.