Modern Monetary Theory in Canada

Modern Monetary Theory (MMT) is a controversial economic theory that has recently been garnering renewed support in Canada and many other developed countries currently struggling with deficit spending. As politicians increasingly look for ways to fund elaborate spending promises for various vote-garnering social programs, MMT’s promise of “self-financed” government spending has proven to be an irresistible siren call for those policy-makers and activists who believe that budget constraints simply no longer matter. While MMT has recently been rising on a tide of populist support, the backlash against its theories from the academic community has been both swift and unrelenting, with critics from almost all major economic schools of thought coming together to condemn the dangers inherent in MMT’s widespread application.

At the heart of MMT is the concept of “monetary financing”,  whereby all spending by the Government is simply funded by newly-created money from the Central Bank. Under this theory, governments have no need to tax their population for revenue, nor access the debt markets for interest-bearing loans to fund social programs and other government projects. Rather, if the government needs funds, it simply creates money out of thin air (via the Central Bank) and spends it. Under this scenario, the only real limitation on government spending is inflation, and the government can, in theory, simply remove money from the economy via taxation if this ever becomes an issue. The risk that most critics point out, of course, is that governments simply cannot be trusted to respond to an inflation problem in a responsible and credible manner if it means cutting back on the various social programs that the general public has come to rely on an everyday basis.

What few people realize is that no country currently engages in MMT-like operations quite to the extent that Canada does, with “monetary financing” routinely conducted by the Government of Canada (GoC) and the Bank of Canada (BoC) as part of regularly scheduled bond auctions. Currently, when the GoC needs to borrow money to fund spending they simply issue bonds and treasury bills which they auction off to various bidders in the primary market, usually on a competitive basis to primary dealers. What is generally overlooked is that the BoC also purchases approximately 15% to 20% of auctioned GoC bonds and treasury bills on a non-competitive basis using newly-created money they simply conjure “out of thin air”. In exchange for the bonds, the Bank of Canada credits the account that the GoC maintains at the BoC, and the GoC is subsequently free to spend down this account on salaries, military equipment, social programs, or whatever else they so please. Using the method of double-entry accounting, the BoC records the bond as an asset on their balance sheet, and records the new GoC deposit at the BoC as a corresponding liability.

But if the BoC is now the holder of GoC bonds, doesn’t that mean that the GoC (and by extension, the tax-payer) must now pay interest to the BOC? In other words, since this type of financing is hardly the definition of “free money” for the government, how does it aid the government with financing its spending programs any more than if it had simply gone to the private debt markets for a normal loan? The answer to this question lies in the fact that as a crown corporation of the Federal Government, the BoC is required to return all interest payments on the assets it holds back to the government. In effect, through its bond issuances, the GoC is essentially gifted interest-free funds to support government programs with money the BoC simply printed into existence.

The above process, it should be noted, is strictly a Canadian phenomenon since, unlike most other countries in the developed world, Canada operates without a fence around its Central Bank. This is to say that most other nations today explicitly forbid their central banks from directly financing government spending. In other words, Central Banks in other countries cannot simply purchase bonds directly from the government to directly fund new programs, but are instead limited to purchasing bonds on the secondary market.

It is relatively unknown to most Canadians, however, that this type of monetary financing is really nothing new. The BoC has in fact been printing money to fund government deficits since the 1930’s, with the portion of outstanding GoC bonds held by the BoC reaching a post-WWII peak of approximately 25% in the 1950’s. Few people realize that monetary financing of government spending has essentially been occurring continuously since the establishment of the Bank of Canada in 1934. Today the BoC predominantly purchases GoC bonds to offset the liabilities it incurs for printing new currency, but regardless of why it is engaged in monetary financing, it is nonetheless creating new money out of thin air to support government spending at zero cost to the GoC.

Yet if the BoC routinely monetizes GoC debt and has been since the 1930’s, what exactly is the concern over MMT? Indeed, MMT advocates often point to the fact that Canada has been engaged in monetary financing for decades without any serious inflation problems, and that given the relatively benign inflation problems to date, BoC financing of GoC debt should be expanded to fund social programs for the betterment of its citizens. Along these lines, several groups have actually brought forward petitions (sponsored by Green Party leader Elizabeth May) and lawsuits to force the government to mandate monetary financing on a grand scale rather than borrow from the private debt markets and subsequently burdening taxpayers with the corresponding interest costs.

What is interesting with respect to the willingness of the BoC to expand its financing of new government programs, is that this is effectively what occurred in 2011 as part of the government’s Prudential Liquidity Management Plan (PLMP). In an effort to create a “disaster fund” of sorts in the event of a future financial crisis, the BoC simply acquired an extra $20 billion of government bonds with newly-created money, deposited the $20 billion payment into the government’s account at the BoC, and returned all interest payments made by the GoC back to the government. As a result, the GoC is now sitting on a $20 billion stockpile of funds acquired with money simply “printed” into existence by the BoC, all essentially with zero cost of funds to government.

It is true that, on the surface, this type of operation may seem relatively benign since the government has no intention of actually spending down their account unless a crisis were to actually develop. But what exactly are the limitations on the government simply directing the BoC to do the same type of operation again, but this time using the money for various social programs like health care, education, or employment insurance? The answer, of course, is that there is clearly no legal impediment given the lack of fence around the BoC. The only thing stopping this type of operation from being undertaken on a grand scale is the self-imposed discipline of our elected government officials and the voting public they ultimately answer to.

This is not to say that large-scale monetary financing by the BoC is inevitable or even necessarily likely, only that this type of debt monetization is already widely used and has been in place for some time in the Canadian monetary sphere. All of the plumbing necessary to undertake monetary financing in Canada already exists, ready to be enacted at a moment’s notice as soon as the necessary public consensus exists to provide cover for politicians to pursue expansionary fiscal policy without limit. While MMT is a political view of how deficit spending should be used to provide the general public with unlimited social programs, the mechanism by which it proposes to finance this spending is in fact already “ready-and-waiting” in Canada.