Monday, July 26, 2021

Are the Bank of Canada's bond purchases illegal?

Pierre Poilievre, Conservative MP for Carleton, alleges that the Bank of Canada's bond buying program contravenes the Bank's powers enunciated in the Bank of Canada Act.

Allegations that the Bank of Canada has broken the law should be taken very serious. They should not be made lightly, either. We give our public servants at the Bank of Canada a wide range of powers to enact monetary policy, but only within the bounds that we permit them.

Poilievre has been actively criticizing the Bank of Canada's pandemic response ever since Covid-19 hit in 2020. I can't say I've ever seen as much Bank of Canada-targeted criticism emanating from a single Canadian politician since Poilievre began his campaign. It breaks with a long Canadian political tradition of staying (mostly) silent on the Bank of Canada's operations.

I have mixed feelings about Poilievre's approach. Yes, it's great to have more public discussion about arcane topics like the Bank of Canada Act. On the other hand, up till now Canada has avoided most of the hyperbole and conspiracies that bedevil U.S. central banking. It would be nice if things stayed that way.

Poilievre's allegations were first aired in Parliament in June. A month later he posted them on Twitter, where I became aware of them. (They garnered over 900 retweets, which is a lot for a tweet about an arcane issue like the Bank of Canada Act!) Poilievre's claims are based on his reading of Section 18(j) of the Bank of Canada Act. Section 18(j) allows the Bank to make loans to the Federal government, but those loans should not "exceed one-third of the estimated revenue of the Government of Canada for its fiscal year."

Poilievre calculates that given 2021 government revenue estimates, this would cap Bank of Canada loans to the Federal government at $118 billion. Poilievre then points to the Bank of Canada's purchases of Government securities, which have pushed the Bank's holdings of Federal government debt above the $400 billion level. Poilievre suggests that this contravenes 18(j).

The allegations caught the attention of columnist Andrew Coyne, who takes a dig at Poilievre:

In fairness to Poilievre, it's not unimaginable that the Bank of Canada has done something illegal and no one has noticed but him. 

Back in August 2007, after all, the Bank of Canada announced its intention to extend its purchases of certain kinds of securities. It was responding to the first signs of a nascent crisis in credit market. Unfortunately it lacked jurisdiction to purchase these instruments. Its actions were unwound by September 2007 in order to bring the Bank back in compliance with the Bank of Canada Act.

I only know this because I phoned the Bank of Canada up that August wondering what legal justification it had for its actions. Several awkward conversations later, it was apparent that a mistake had been made by bank officials.

My observations made their way into a report that December for the CD Howe Institute. From there a process to update the Bank of Act began. After discussions in Parliament (including a contribution from then-governor Mark Carney here) the eventual result was an update to the Act in the spring of 2008. Tucked into Bill C-50, changes included striking out Section 18(k) and rewriting Section 18(g).

These modifications to the Bank of Act made it permissible for the Bank of Canada to conduct the purchases it had originally set out to do in August 2007, and prepped it for the much bigger fallout to come: the September 2008 credit crisis.   

So maybe Poilievre has caught a breach of law. It's happened before. That being said, echoing Coyne (who cites economist Mike Moffatt), I'm not convinced by the meat of Poilievre's argument.

In response to Poilievre's allegations about 18(j) being broken, Bank of Canada officials would probably respond that their large-scale asset purchases are authorized under Section 18(g).

The Bank of Canada's ability to make securities purchases for monetary policy purposes is set out in Section 18(g), which replaced the much narrower 18(k) in 2008. The scope of Section 18(g) is very broad. First, it is open-ended about what instruments it allows the Bank to purchase. These securities can include bonds, stocks, commercial paper, mortgage-backed securities, and more.* Second, 18(g) doesn't say anything about the Bank's purchases needing to happen in the open market. If necessary, the Bank of Canada can buy straight from the issuer.

The bit of legalese that Poilievre points to, 18(j), only applies Bank of Canada loans to the Government, say a line of credit or some other type of credit facility. Because the Bank has limited its interaction with the government to buying securities, 18(j) hasn't been triggered. And so Poilievre's allegations are just that, allegations.

Section 18(j) was devised to prevent the Bank of Canada from financing the government and preserving the Bank's independence, as Poilievre rightly points out here. And I think that's a laudable goal.

In that spirit, it's worth considering that most (but not all) of the Bank of Canada's purchases of government bonds have occurred in the open market. That is, most of the securities in the Bank's government bond portfolio were bought only after the public had initially purchased them from the Government. So in a sense, the Bank has prudently removed itself from the initial price discovery process.  

More specifically, the Bank has purchased $362 billion in Government bonds since March 2020. Of that amount, $303 billion, or 84%, was bought in the open market. The remaining $59 billion was bought directly from the Government.

Even when the Bank does participate in bond auctions, it does so on a non-competitive basis. That is, the Bank pays the average of all competitive bids submitted to the auction. The competitive bids are provide by banks and other primary dealers. This practice further prevents the Bank of Canada from playing an active role in setting the government's cost of capital.

So to sum up, I think the Bank of Canada is on firm legal ground. Furthermore, I also think the spirit of 18(j), a prohibition on financing the government, remains intact.

* The one security that Section 18(g)(i) deems to be off limits are instruments that "evidence an ownership interest or right in or to an entity." If I recall correctly refers to certain types of asset-backed commercial paper (ABCP).


  1. Also the recipient of the money in those transactions is not the government , it is the bond holders. ie the loans have already been made, the government has already been funded. Regarding independence, it could be argued that if the Banks entirety of assets is Government bonds then it has less independence.

    1. "Regarding independence, it could be argued that if the Banks entirety of assets is Government bonds then it has less independence."

      That's a fair argument. (I've made it before:

      The counterargument is that there is nothing safer or more liquid than a government bond. The corporate bond market is fragmented and illiquid, gold is volatile. A central bank can best preserve its independence by holding the safest most liquid assets.

  2. Beyond legal issues, the way I see it is the Govt could issue short term bonds with two options: selling bonds to the CB or selling them to the public.
    If the public doesn't have demand for them, the Govt would have to offer higher rates. That would compete with the interbank rate which would go up and the CB would have to intervene to lower it.
    That would efectibly mean that the Govt would be financing the Govt indirectly. Let's suppose that the CB "printed" reserves to directly fund the Govt without any bond issuance. That would mean that when the Govt spends those reserves would "enter" the market lowering the interbank rate, and so the CB would have to sell bonds to intervene. That would mean that the Govt would have to pay interests to the public instead of paying them to the CB which ultimately return to the Govt as CB earnings.
    It doesn't matter which way the CB finances the Govt. The Govt actually has the "printer machine" one way or the other.

    1. "Let's suppose that the CB "printed" reserves to directly fund the Govt without any bond issuance. That would mean that when the Govt spends those reserves would "enter" the market lowering the interbank rate, and so the CB would have to sell bonds to intervene."

      Yes, that's right.

      But personally I would prefer the second scenario in which the central bank "prints" reserves by buying government bonds at a competitive auction.

      As you say, once the government spends its new reserves, the Bank of Canada has to sell bonds to support the interbank rate. But if the Bank didn't get any bonds in the first place from the government, then it doesn't have anything to sell. All it has is an illiquid IOU. On the other hand, if it has a standardized marketable bond, then its task is much easier.