Speech by Toni Gravelle / Discours de Toni Gravelle

Good afternoon. And hi Sue, we met a few times in the past. It's nice to see a familiar face. I always enjoy engaging with CFA charter holders. Every day in my role as Deputy Governor focused on financial markets, I use a lot of market lingo that I will be able to use more easily and more freely within the Q&A session than I can in some other groups. I must also say that it's really weird wearing a suit in this stay-at-home environment. It's been a long time, and my dress shoes are killing me.

It's hard to believe we've been dealing with this for a year. The Bank of Canada's role is to make sure that the financial system works smoothly, especially in tough times when people depend on credit more than usual. So a year ago, the bank took unprecedented action to ensure that the financial system could keep functioning normally and that the economy could recover. These goals are intertwined. Markets have to work for the economy to work, not just for bankers and asset managers, but for Canadians of all walks of life. An essential part of markets working well is liquidity, the ability to buy, sell, lend, and borrow with relative ease. Think of it as the grease that keeps markets lubricated. When COVID-19 struck last year, it caused enormous uncertainty about the economic outlook. Investors scrambled to sell their financial assets, even those normally considered risk-free such as Government of Canada bonds, so they could meet their margin calls and build up their cash buffers. With this dash for cash so widespread, everyone was looking to sell assets and few were willing to buy. Markets came under extreme stress and seized completely. Households and businesses also became extra cautious. Companies were drawing down their lines of credit at an unusually fast pace, and households were building up their savings or deferring loan payments. At the height of the crisis, the bank's top priority was to quickly restore well-functioning markets so that households, businesses, and governments could still access credit, either directly from markets or from banks and credit unions.

However, our decision to act was not something we considered lightly. There is a high bar for using these extraordinary tools. The last time we stepped in to address issues like this was more than a decade ago during the global financial crisis. With that in mind, I'll begin by reviewing how the bank responded to the market-wide stress, then I'll talk about our thinking behind our actions and update you on the status of our facilities. Since markets have returned to working normally, our actions have grown the bank's balance sheet substantially, so I'll close by discussing some policy implications of this and what my Governing Council colleagues and I are considering as we explore the path ahead.

Uncertainty and fear gripped markets. A dash for cash mentality took hold across financial market participants, and liquidity dried up throughout the financial system. The bank responded swiftly and supplied extraordinary liquidity, in line with our role as lender of last resort, which I'll come back to in a moment. We launched a broad suite of programs, including some that we used during the global financial crisis and others we created from scratch. We started by addressing the severe immediate liquidity issues affecting financial institutions in Canada. We knew that if we helped supply them with funding, they would be able to meet the greater demand for credit coming from other parts of the financial system, as well as from households and businesses. So the first action we took was to expand our term repo operations.

In supporting market functioning more generally, we increased the frequency and size of these operations, peaking at $24 billion per operation, and offered funds for longer terms. We also let financial institutions use a wider range of securities as collateral, which made it easier for us to lend them larger amounts than usual. Throughout these extended term repos, we lent roughly $200 billion to financial institutions in March and April alone. We also launched our Contingent Term Repo Facility that broadened the list of financial institutions we engage with for these operations. This provided liquidity to large asset managers that are active in repo markets. The dash for cash also affected core funding markets, such as the market for Government of Canada bonds. These bonds are very safe and serve as the benchmark or reference rate for almost every other credit market. If the Government of Canada bond market can't function smoothly, it's hard for the rest of the system and the economy to work properly. Starting in mid-March last year, the bank rolled out several new asset purchase facilities to support liquidity and restore smooth functioning in a wide range of markets. Our ability to do this quickly and effectively is a testament to the caliber, dedication, and expertise of our staff, many of whom, like you, hold CFA designations. The bank's purchases helped rebalance the lopsided trading flows in core debt markets, allowing buyers and sellers to set prices. Also, because securities dealers only have limited balance sheet capacity, our purchases helped them intermediate more effectively.

We started with programs designed to unfreeze markets that are key sources of short-term funding for businesses and governments. For example, to support the capacity of commercial banks to support businesses' credit needs, we launched the facility to buy bankers' acceptances. We also began purchasing commercial paper to provide funding for a wide range of companies and financial institutions. We began making large-scale purchases of Government of Canada bonds in the secondary market. We launched the Government of Canada Bond Purchase Program at a weekly pace of at least $5 billion across the spectrum of short-term and long-term bond maturities. Later, the focus of the program pivoted from restoring market functioning to providing additional monetary policy stimulus.

We also announced programs to buy up to $50 billion of provincial bonds and up to $10 billion of high-quality corporate bonds. Collectively, our actions and those of other major central banks in their own jurisdictions helped stabilize global financial conditions. The steps we took in Canada to support core markets reflected our responsibility to act as lender of last resort when the financial system is short of liquidity and under stress. This role goes back centuries. The original description of a central bank's role as lender of last resort came in 1802 from Henry Thornton, an economist and leader of Britain's abolitionist movement. But it wasn't until the late 1800s that British journalist Walter Bagehot created the best-known doctrine.

Bagehot said that in a panic, the central bank should lend freely at a high rate of interest on good collateral. In the 19th century, the main source of funding for banks was deposits. But in modern times, where financial markets have become another important source of funding, the lender of last resort role of central banks has evolved. Today's lender of last resort can be thought of as liquidity provider of last resort, ready to resolve market stresses when the financial system cannot find its footing and when debt markets are frozen. At the same time, Bagehot noted that while it was important to reduce financial stress, it was also critical to do so in ways that mitigated moral hazard. This remains true today. Moral hazard emerges whenever market participants and other economic actors feel that they can engage in risky behaviors without bearing the consequences if things go wrong. Moral hazard can be addressed in several ways. For one, central banks should scale back crisis tools to show that they are emergency measures and don't reflect business as usual. Facilities can also be structured in ways that discourage market participants from relying on them in normal times, for example by offering liquidity at a cost above typical market rates. The bank's response to market-wide stress last year included some programs that carried different degrees of punitive pricing and others that did not, because our top priority was to thaw frozen markets quickly. We felt that punitive pricing could undermine that critical objective. In some cases, we also lent at prevailing market-determined rates through an auction process but sought to minimize moral hazard through other means.

Major central banks, international authorities and regulators, and policy organizations such as the Financial Stability Board are actively studying these issues too. In addition, we are all looking at whether any further structural reforms could be made to improve the resilience of the financial system and minimize the likelihood that extraordinary tools will be needed in the future. The main point is that when central banks provide liquidity, we have to do so in ways that don't encourage market participants to take undue risk in normal times. Our actions must be targeted at specific issues and scaled back as those are resolved. That is why we gradually adjusted our facilities as conditions improved. In the autumn, we wound down a couple of facilities, including the program to support bankers' acceptances and the commercial paper purchase program.

The bank will suspend or discontinue crisis programs, specifically liquidity market-focused crisis programs. We will suspend our term repo operations indefinitely beginning mid-May. Similarly, the Contingent Term Repo Facility will be deactivated in early April. We can take these steps because there is now ample system-wide liquidity for financial institutions to draw from. This is both in terms of their own unusually high levels of deposits, as Canadians save more during the pandemic, and the large amount of cash, more specifically settlement balances, that we have added to the financial system. In addition, the commercial paper as well as the provincial and corporate bond purchase programs have largely normalized to pre-pandemic levels. So it's clear that these extraordinary facilities are no longer required. Rest assured, though, that the bank will be ready to reactivate any of these market programs should severely stressed market conditions ever re-emerge.

As I said at the outset, our facilities and purchases of financial assets have grown the bank's balance sheet considerably. It now stands at close to $575 billion, more than four times bigger than before the pandemic when it was roughly $120 billion. Ultimately, our actions to support liquidity and markets provided timely support for the economy too. They ensured that the impact of our very low policy rate could be felt in all corners of the economy and that credit could flow.

I think of the bank's balance sheet in two buckets. The first bucket contains our holdings generated from the facilities aimed at supporting market functioning. The second bucket holds our Government of Canada bond purchases. As I noted a few minutes ago, at the height of the market stress, these Government of Canada bond purchases were largely aimed at supporting market functioning. You may recall also I said that as we moved into the summer, the purchases' main impact shifted to bolstering our monetary policy stimulus. Making large-scale purchases of Government of Canada bonds is known as quantitative easing, or QE. QE works through different channels, and the importance of each depends on what's happening in markets and the economy. During times of market stress, QE purchases mostly help improve liquidity, ensuring that the GoC bond market and other debt markets can function.

Our facilities for market functioning caused the rapid growth of the balance sheet during the worst part of the crisis last year, roughly from March to the end of June. By the end of April 2021, though, Government of Canada bond holdings are expected to be the largest piece of the balance sheet by far, at roughly $350 billion or more than 70% of total assets. This is not unusual, as Government of Canada bonds are typically the largest asset on our balance sheet. What's different now is the sheer size of those holdings. Still, measured against the size of our economy, the value of QE assets we've purchased since last March is broadly similar to many other central banks. We are below the Bank of England, about tied with the U.S. Federal Reserve, and ahead of the European Central Bank and the Swedish Riksbank.

Our balance sheet relative to GDP is by far the highest among this group of central banks. Let me now turn to how these could evolve. The increase in the balance sheet from programs directed at market functioning will largely roll off because many of those were focused on short-term market support. This has already happened for our purchases of short-term assets such as bankers' acceptances and commercial paper. For short-term funding facilities such as term repos, the process is well underway. Most significantly, about $120 billion is set to roll off between mid-March and the end of April of this year. As it does, the bank's balance sheet, after being relatively stable since July, will decline to about $475 billion.

Our holdings of provincial and corporate bonds currently sit at just over $17 billion. At this point, the bank does not intend to sell any of the assets purchased through either of these purchase programs. Of note, at the end of June, we will release transaction-level details for the asset purchase programs that are expiring and for the facilities and programs that have already been discontinued. This supports our commitment to be fully transparent about our actions once the programs have ended. Regarding our ongoing purchases of Government of Canada bonds, Governing Council is evaluating how the process of adjusting these could unfold. During the current purchase phase of QE, we continue to add monetary policy stimulus because our GoC bond holdings are growing. In October, we recalibrated our purchases to a minimum of $4 billion without reducing the overall stimulus coming from QE.

At the time of the January Monetary Policy Report, we indicated that if the economy plays out in line with or stronger than our economic projection, we won't need as much QE stimulus over time. And in our March policy decision statement, we said that as we continue to gain confidence in the strength of the recovery, we will gradually adjust the pace of our QE purchases. We also indicated that first-quarter growth is likely to be better than we expected in January, and we will have a new economic projection at our April policy decision. I want to be clear here: moderating the pace of purchases while adding to our holdings would still be adding stimulus.

When we start gradually dialing back the amount of incremental QE stimulus we are adding, we will eventually get down to a pace of QE purchases that maintains but no longer increases the amount of stimulus being provided. That is a pace where our Government of Canada bond holdings are largely stable, and we reinvest the proceeds of any maturing Government of Canada bonds. At that point, the accumulated amount of Government of Canada bond holdings would still represent a significant amount of stimulus in the system. I'd like to stress a few things about our journey to this reinvestment phase of QE. First, the process of getting there will be gradual and in measured steps. Second, the timing of these moderations to the pace of purchases and the amount of time we take to get to the reinvestment phase will depend on the strength and durability of the recovery.

We will need to start raising our policy interest rate. These decisions are distinct. We have committed to continuing our QE program, by which we mean positive net purchases, until the recovery is well underway. Meanwhile, our decision on the policy rate is linked to the economic outcomes described in our forward guidance, which says that we will leave the policy rate at 0.25% until economic slack is absorbed so that the 2% inflation target is sustainably achieved. In the forecast we published in January, we projected that this wouldn't happen until into 2023. So we would arrive at the reinvestment phase of QE some amount of time before we start increasing our policy interest rate.

How long it takes to transition through these different steps will of course depend on how the trajectories for economic activity and inflation unfold. As part of this journey, we will be mindful of the possibility that our stimulative monetary policy, while essential to achieving our inflation objective, could increase financial vulnerabilities. Rest assured that throughout the normalization process for monetary policy, we will make every effort to communicate clearly and in a timely manner. It's time for me to conclude. We have come a long way from how things were a year ago, when severe market-wide stresses forced the bank to act as lender of last resort to the financial system. Our efforts in the face of COVID-19 have had their intended effect. Financial markets have been working much better.

The bank's continuation of several facilities and programs reflects the fact that these were extraordinary central bank actions, and it always was our intention to withdraw them once we became confident that financial markets could function normally without them. Such actions must be reserved for times of severe market stress, and as such, they are not a substitute for steps that market participants take on their own in normal times to manage their risk. While the assets we acquired in the recent crisis to support market functioning will decline, our QE program that supports our monetary policy actions is continuing to add to the bank's balance sheet. As new information on the strength of the recovery arrives, Governing Council will continue discussions about gradually moderating the pace of our QE-related purchases.

Thank you for your attention. Now I'd be happy to take some questions.

We've been monitoring the recent steepening in the yield curve. It's important to understand why the yield curve is steepening. We've seen a series of good macroeconomic news, and there are increasing signs that the recovery is improving. We also take into account when we make our policy decisions global financial conditions, including financial conditions in Canada. This incorporates not only the yield curve but also credit spreads, stock market valuations, among other things. As such, financial conditions always play a role in our decision-making process and our outlook for the economy.

Our focus is on credit markets, debt markets. Our intention is to make sure that the markets are unblocked and that credit flows freely across the financial system so that businesses, households, and governments have access to that credit, and that credit allows for a rebound in economic activity. So it's kind of way out of the details, and I don't think it would be our go-to for any foreseeable kind of crisis.

A stronger housing activity is one of the factors that upgraded our outlook for Q1, as we mentioned in the March statement. We're seeing much stronger housing activity than we expected, so it's always a factor in our macro outlook and also a factor in our policy decision-making. As the Governor noted, we are starting to see signs of excess resilience, but as yet they don't seem to be as severe or as strong as we saw in 2016 and 2017. Part of our analysis is trying to distill between what are fundamental factors driving house prices and what is exuberance. We're trying to understand how much exuberance is driving the prices. One of the concerns we have is that there is starting to be fear of missing out, and that might be driving some of the expectations. We'll have more analysis in our May FSR, and we're also putting out in the next couple of weeks an annotated chart package of the housing indicators we're looking at.

When we decide and analyze our decisions related to monetary policy, we have first and foremost always maintaining or getting to our inflation objective. So to the extent that we have this trade-off all the time, we have a financial stability side to our decision-making process. We'll have some more analysis in May. As we look at housing, we take both the macro impact of housing in terms of the economic outlook and our decision in terms of the policy rate and our objective of meeting the inflation target, and we have a framework in place that addresses these issues.

As I mentioned in the speech, what we're looking at is the strength of the recovery. As we mentioned at several policy statements, we are looking for signs of the recovery being well underway. So we're keying our decisions related to changing the pace of QE off of the strength and durability of the recovery. For our interest rate policy, we're keying decisions related to that as related to what we've mentioned in our forward guidance.

Can you hear me? Yes, I can, but I can't see you, sorry.

Oh, they're still there? Okay, I'm getting signs that you guys are all on. Okay, good. My apologies.

Big question. I'm going to take bits and pieces of that; it's quite wide-ranging. In terms of cryptocurrencies, there are certain types that are better as a means of payment than others. Transactions using Bitcoin are just too expensive in terms of service charges, and their purchasing power is much too volatile. Stablecoins have better prospects of replacing money, but none are near that point of being a replacement. One of the reasons they have better chances is that their purchasing power is much more stable, as the name implies. The bank, as you know, has been exploring and doing a lot of work on a central bank digital currency, or CBDC. We have not made a decision to issue one, nonetheless. Any decision to issue one would be keyed off two conditions: one, that there's a sudden drop in acceptance of cash in Canada, and second, that there's a cryptocurrency that's increasingly dominant as a medium of payment but has flaws that might jeopardize the financial system. So we have an ambitious work plan related to developing our CBDC and being ready to issue one if these conditions ever appear. That's going at a fairly decent pace. I refer you to a speech by my colleague Tim Lane for more details. In terms of taking cryptocurrencies into our outlook, and gold, I think we look at a broad range of financial conditions, but not necessarily those asset prices per se.

The bank has been doing a lot more analysis related to inequality, not necessarily related to our day-to-day monetary policy process, but understanding the structural factors underlying it. We place a lot of importance on inclusive issues. We recently published a DNI strategy which has targets related to the number of women in senior management roles. We think the economy is better served by having a diversity of views, diversity of actors, diversity of workers in the system, and it'll be driving a better and more innovative economy at the end of the day.

I think there's a lot of analysis between having too low an inflation rate, which causes too much friction, and of course too high an inflation rate, as we lived through in the 70s and 80s, which has a long-term drag on potential economic growth. So in terms of the inflation target, 2% is considered stable. Just to be clear, we have a 1% to 3% control band around that 2% inflation rate. It's very clear that one of our main concerns during the COVID crisis and the economic contraction is that our tools are somewhat less effective in terms of disinflationary dynamics relative to inflationary dynamics. We have a proven set of tools, raising the policy rate in particular, that we are very comfortable using if we saw persistent levels of inflation above our comfort zone, which is 3%. The inflation band is between 1% and 3%.

In markets, there's a dispersion of views. There are views that think inflation is going to be above 3%, views that think it will be between 2% and 3%, and views that think it will be between 1% and 2% or below. That dispersion is captured in market prices, and as that dispersion shifts over time, the mean or median is reflected in market prices. My understanding, looking at more recent numbers in terms of breakeven inflation for long-term inflation, is actually lower than short-term breakeven inflation measures. If you look at two-year breakeven inflation measures, we have an inverted breakeven curve. Our own forecast is that we'll see a spike in Q3 where inflation will move to the top of our 3% range before being pushed down, given the still ongoing excess capacity in the economy. So our perspective is kind of in line with what we're seeing in markets. The levels right now in terms of breakeven inflation are not too far out of our 1% to 3% inflation band. So I think it's not too big of a concern at the moment. What we would be concerned about is sharp destabilizing moves in yields.

It's true that roughly since the early 2000s, interest rates have been on a downward trend globally. This trend has honestly been a trend since the late 1990s or early 2000s. Taking a longer-term perspective, we are living in a world where the trend rate of growth and the neutral rate of interest, which is our star, has an implication for the policy rate. Policy rates as well as bond yields are going to go down over time. There are a couple of factors driving our star to go down: one is demographics, the aging of the population; the other is lower productivity that we've seen. To the extent that those trends in demographics and lower productivity, among other factors, are keeping our star, the neutral rate of interest, down at these low levels, it's very likely that we'll be at these levels for an extended period of time. That also means that our policy rate will hover at these low levels for some time.

Thanks, it's been great.