The letter, "Borrow from Bank of Canada", January 24, 2009, propagates a misconception that there is a costless way to pay for government spending by borrowing from the Bank of Canada (BoC). I would like to point out some problems with the author's reasoning.
To begin with he writes, "Banks must be finding it hard to contain their glee at the propect of the federal government running deficits that could amount to $100 billion..." (in anticipation of all the interest income). There are two problems: first, banks usually are not the ones that lend to the federal government. The money comes from investors such as people saving for
retirement through pension funds, mutual funds, and life insurance policies. Banks are in the business of making riskier and higher yielding loans such as to businesses, entrepreneurs, and home buyers. Second, investors holding government bonds won't be gleeful. On the contrary, when the federal government sells bonds to finance its spending, that extra supply will push down the value of investors' bonds.
The author is correct in saying that financing government spending by borrowing directly from the BoC is like telling the BoC to print money and give it to the government. Printing $100 billion certainly could be inflationary. As the author suggests, to prevent inflation, the BoC could force commercial banks to put an extra $100 billion in reserve but that would be $100 billion no longer available to finance the investment and job creation that we sorely need now. It would be like slamming the brakes on the economy. The BoC could raise interest rates to prevent inflation, but that would have the same effect of slowing down the economy.
On the other hand the BoC could be instructed to stand back and let the Loonie inflate. That is a valid policy choice, but we should be clear to Canadians what is really being proposed in that case. People on fixed incomes and indeed the whole economy would have a certain price to pay. Also, the independence of the Bank of Canada from political influence would be threatened.
The unsurprising truth is, there is no free lunch. But it's also true that the Government of Canada can borrow money at the lowest possible interest rate on Canadian dollars because there is no risk of default - it could always print the dollars needed to repay those loans. The cost of borrowing money is not the issue. The issue is, in this time of economic crisis, whether our federal government chooses the right things in which to invest that money.
Original Article:
Borrow from Bank of Canada
Banks must be finding it hard to contain their glee at the prospect of the federal government running deficits that could amount to $100 billion over the next few years. Even at 3% interest, that would amount to a perpetual income of $3 billion and a perpetual charge to the government. This interest would be added to the $63 billion we are already paying every year on the debts of our three levels of government.
The sad part is that the added cost of this interest is entirely unnecessary. The federal government could borrow money interest-free from the Bank of Canada. The government owns the Bank of Canada, so profit from the bank is returned to the government as a dividend.
When the government borrows from a bank, the bank creates the money it lends simply by entering a credit in the account the bank has set up for the government. The government then draws upon this credit and pays whatever interest is charged. When it borrows from commercial banks, the interest charged remains with the bank. When it borrows from the Bank of Canada, the interest charged eventually returns to the government minus a tiny amount for the cost of administering this process.
So why does the government borrow from private sources? Ask your MP. The answer, if you are not ignored, will likely be that doing so would cause inflation by putting too much money in circulation. To counteract this, the government must reinstate the statutory reserves that were disring the Brian Mulroney government. This would require the commercial banks to put money in reserve to reduce the amount in circulation. Richard Priestman Kingston
