Published on May 11, 2016

On April 3, 2009, I was a panelist at the third Annual Student Conference on Business Research held at HEC Montreal on the topic of “The Financial Crisis: What’s Coming Tomorrow?”. This is the English translation of my presentation. It is a slightly modified version of the speech I gave in St-Georges-de-Beauce and Calgary this past January. — 22 April 2009

How to react to the economic crisis? A presentation at HEC Montreal

Economics has always been my favourite topic of interest: how to help our compatriots to realize their dreams and to better their lives and, by doing so, to make a better world for all of us. 

Today, I would like to discuss this crisis with you. I wish in particular to bring your attention to the monetary policies of central banks. Because they play a crucial role in the current crisis.

My thinking on this issue has been inspired by the great economist Friedrich Hayek, who received the Nobel Prize for economics in 1974 and passed away in 1992.

He and his colleagues – who belong to what we call the Austrian school of economics – have for many decades warned us about the adverse consequences of central banks manipulating the money supply.

Central banks are continually increasing the quantity of money that is circulating in the economy. In Canada for example, if we use the strictest definition of money supply, it has increased by 6 to 12% annually during the past dozen years. The situation is about the same everywhere.

The consequences of constantly creating new money out of thin air have been a dramatic increase in prices and a debasement of our money. The faster the quantity of money increases, the higher will the inflation level be and the larger the reduction in the purchasing power of each dollar.

An inflation rate of 2% a year may seem small. But when you add up 2% of depreciation of the monetary unit year after year, you end up with large numbers. Total inflation in Canada from 1990 to today adds up to 42%. This means that your dollar can now buy the equivalent of only 70 cents if you compare it to 19 years ago.

This inflation eats away at our revenues and our financial holdings. It is the equivalent of a hidden tax.

Besides pushing prices up, what happens when central banks maintain artificially low interest rates? That is, rates that are lower than the natural rate of interest, which should balance the supply of voluntary savings and the demand for investment funds?

Well, what happens is that people are encouraged to save less, because the returns on savings are lower. And they are led to carry more debt, because credit is easier to obtain.

This is precisely what we have been doing in Canada, in the U. S. and elsewhere in the world for the past 20 years. In 1990, the ratio of total debt to disposable income for Canadian families was 90%. Today, this ratio has gone up to 130%.

In 1990, Canadian families used to save about 10% of their disposable income. Today, their savings rate is down to 1%.

Many people thought that there was no problem there because the assets of Canadians would continue to grow to compensate for these larger debts. In particular because house prices had been going up since the late 1990s, and because funds set aside for retirement were increasing in value. But with the slowing down of the real estate market and the stock market crash, we now know that this too was a monetary illusion.

Which brings us to another consequence of monetary manipulations which has the effect of wrecking the economy: the creation of artificial booms followed by busts and recessions.

Remember: we had the dotcom bubble at the end of the 1990s. And now we’re experiencing the burst of the real estate and financial bubble that followed.

Between 2001 and 2004, in order to stimulate the economy after the dotcom crash, the Federal Reserve pushed down interest rates to as low as 1%. If you factor in the level of inflation, real interest rates were negative. This is the same as subsidizing people to encourage them to take loans. But we all know this lesson: you cannot live on a credit card for very long!

This bubble was made bigger by the policies of the U. S. government. It encouraged banks to extend risky mortgages to insolvent borrowers; and it encouraged people to take up these mortgages and buy houses that they could not really afford. All of which contributed to an unsustainable increase in house prices of 10 to 15% per year.

In 2006, 22% of all new mortgage loans in the U. S. were subprime.

You’ve heard the rest of the story. These mortgage loans were securitized and then sold on the market around the world. And the financial institutions that had bought them got into trouble when home owners started to default and home prices went down.

Another reason why this financial crisis reached global proportions is that central banks elsewhere in the world have had more of less the same expansionist monetary policies as the Fed. We got to a point where there was too much money and credit available, and these funds were invested in too risky and unprofitable places.

Economic downtowns are always preceded by an inflationist boom. The Great Depression happened at the end of the “Roaring Twenties.” By allowing the creation of gigantic quantities of money, central banks are responsible for these inflationist booms and for the following crisis.

Now, what should we do to get out of this crisis?

We hear a lot about artificially sustaining demand by injecting even more money into the economy. That’s the Keynesian solution.

But if you inject resources in the economy, where do you take them? They’re not falling from the sky. They have to come from somewhere else in the economy. In effect, you take resources from some and you give them to others. It’s like taking a bucket of water in the deep end of a swimming pool and emptying it in the shallow end.

A government cannot inject resources in the economy unless it has first extracted them from the private sector through taxes; or put us further into debt by borrowing the money; or stimulated inflation by printing it.

We are also being told by some commentators to continue to shop till we drop in order to kick-start the economy. In these uncertain times, when many could lose their jobs, this amounts to inciting people to be irresponsible.

In any case, isn’t this exactly what we’ve just been through? A time when monetary policies were encouraging us to go into debt and live above our means?

This is based on the belief that the more we consume, the richer we get, when the reverse is true: the richer we are, the more stuff we can buy! And you get rich by working, by saving and investing real resources, and by becoming more productive. There are no other ways.

Roosevelt prolonged the Great Depression for a decade with his very interventionist policies.

The Japanese also had recourse to such policies after their real estate bubble burst in the late 1980s. They voted gigantic stimulus packages and the Japanese central bank kept interest rates at 0% for several years. It did not work. The only apparent result is that Japan went from the country with the smallest debt in the G7 in 1995 to the country with the largest debt today. And its economy is still in crisis 20 years later.

The only thing more dangerous than this economic crisis may be our way of responding to it. If we intervene too much or in an appropriate manner, we run the risk of worsening and prolonging the crisis. The best thing to do is to stay focused on the fundamental principles that have been tried and tested: sound money, responsible finances and free markets. We will only find our way back to prosperity, and guarantee the future of our children, if we continue to fight for these values.

Thank you.

Published on May 11, 2016

On April 28, 2009, the governor of the Bank of Canada, Mr Mark Carney, and the senior deputy governor, Mr Paul Jenkins, appeared before the Standing Committee on Finance, on which I sit, to discuss the Bank’s interventions in dealing with the economic crisis. I asked them a question on quantitative easing, which is the method used by the Bank to increase the money supply when interest rates are close to zero. You can also watch this exchange on the following video clip (mostly in French) or read the adapted transcription below. — 5 May 2009

Maxime Bernier: In the annex to your Monetary Policy Report, which you tabled last week, you explain how the Bank of Canada will proceed with what the experts call quantitative easing or, in other words, how it will increase the amount of credit in the economy. You traditionally do that by buying treasury bills.

In the context of this exceptional measure, you could also do so by buying financial assets from the private sector, that is to say the shares or bonds of individual private businesses. The bank will buy those assets by creating money out of nothing.

I must first tell you to what extent this practice of creating money out of nothing and artificially inflating credit troubles me. The inflationary theories of Keynes have been discredited for a number of decades. However, you’d think everyone has suddenly become a Keynesian. If creating new money and inflating credit could really stimulate growth, there would never be recessions or economic slowdowns.

In fact, a number of economists believe that excessive money creation caused this crisis. Excessively easy credit during most of this decade purportedly caused bubbles, particularly in the finance and real estate sectors. A recession occurs when those bubbles burst and the economy has to readjust. If it was easy credit that caused the bubbles and the crisis, I would like to understand how we can hope to get out of the crisis by further increasing credit. By doing that, don’t we risk further distorting the economy?

Some say that quantitative easing is now the path to take, since it is practised at most other central banks of the major countries. However, if Canada experiences a less severe crisis because its monetary policy is more conservative and more prudent than those of its partners, it seems to me that doing the same thing as the others is not necessarily the best option.

Mr. Carney, in your report, you admit that purchasing private assets will increase their prices and that that will be done in a neutral manner with respect to sectors and assets of a similar nature. How can you remain neutral, when there are thousands of different financial assets in various sectors? Isn’t the bank running the risk of putting itself in a position where it will favour certain sectors or businesses over others?

Mark Carney: Thank you for your question. First, I would like to emphasize a few points. The objective of these transactions would be… I’m using the conditional for a reason. This isn’t the Bank of Canada’s plan, but it is one card up our sleeve, only in the event it becomes necessary to promote greater monetary easing as a result of a negative shock. We would have options, such as easing credit rules. The purpose of these transactions is to improve financial conditions, credit conditions across Canada as a whole.

As regards neutrality with respect to similar sectors, we can use adjudication, for example. That is one way to be neutral with respect to certain sectors. It’s one tool used by the Bank of England to ease credit.

With respect to your reference to Mr. Keynes, I would simply like to emphasize that it is more a question of Mr. Friedman than Mr. Keynes, this idea of the relationship between the money supply and inflation. In that context, even though our situation and our financial conditions in Canada are better than elsewhere-and that’s the truth-they are nevertheless difficult and are remaining difficult. The velocity of money fell, so that relationship, that danger is much less, as a result of the recession and the global financial crisis.

Paul Jenkins: There are other techniques that can be used to achieve a neutral impact. For example, we could think of the indices. There are techniques that a central bank can use to achieve a neutral impact.

Mark Carney: The Bank of Canada has no interest in pursuing an industrial policy.

Maxime Bernier: I’m very pleased to learn that you’re talking about quantitative easing in the conditional only and that you won’t automatically resort to it. If Canada’s economic position requires it, you’ll have another option in your tool box. I believe that’s very healthy.

With regard to the neutrality issue, if I understand correctly, it’s perhaps not so much the direct purchase of securities in the stock or bond markets, but rather the indices in the various sectors that could help achieve a neutral impact.

Published on May 11, 2016

20 July 2009

Hello everyone,

As a Member of Parliament for the Conservative Party, I am often described as a right-wing politician. According to conventional ideological divisions, this is what distinguishes conservative politicians from those of the Liberal Party, who are supposed to be in the centre. And from NDP or Bloc members, who are seen as left-wingers.

I have never really liked those distinctions, because I don’t believe they really tell us anything useful.

Left-wingers are seen as supporting progress and equality. But it is well known that under communist regimes for example, members of the party had all kinds of privileges that were refused to ordinary people.

Socialist governments around the world have often adopted reactionary laws against freedom of enterprise that blocked economic progress. Can someone tell me, what is so progressive about forbidding people to make and exchange things to fulfil their needs?!

Right-wingers on the other hand are supposed to favour tradition and freedom. But some moral conservatives try to impose their values by using the coercive power of the state, which is an attack on people’s freedom.

And what about the policies of George W. Bush, whose administration was seen by everyone as right-wing? He practically nationalised the American financial sector, invaded a country without any justifiable reason, and increased the size of the government more than all his predecessors. That has nothing to do with freedom or tradition.

In reality, when we look at history, the values of the left have often been defended by right-wing governments, and the values of the right by left-wing governments.

I prefer to use a more precise rule to define my position: when we are faced with a problem, should the government intervene or should we leave individuals to find a solution by working together? In general, should the government intervene more or less?

My answer is that in general, the government should intervene less. And every time it’s possible, we should defer to the free market and to individual initiative instead of imposing new rules.

This was the guiding principle for the reform of the telecommunications sector that I instituted as minister of Industry. We directed the CRTC to regulate the telecom sector only when it could prove that it was absolutely necessary to fulfil one of the objectives of the law. Otherwise, it should rely on market rules.

Before that reform, the procedure had been the opposite: new regulations were imposed as a matter of course, unless it could be shown for certain that they were not needed.

I have respect and admiration for politicians considered to be right-wing, like Margaret Thatcher or Ronald Reagan. They managed to reduce government interventions in some areas.

But I also respect and admire politicians considered to be left-wing who did the same. For example, Bill Clinton significantly reformed welfare programs, cut down spending and eliminated the budget deficit of the American government. Even French socialists like François Mitterrand liberalised radio and television, which had been monopolies of the state; and Lionel Jospin privatised Air France, France Telecom and other important sectors of the French economy.

The categories of left-wing and right-wing only create confusion. Many people do not really understand what they mean, with good reason. There is no confusion when you say that you either favour or not less government intervention and more individual freedom and responsibility.

I will have other occasions to discuss these principles in more detail.

Goodbye for now.

Published on May 11, 2016

While putting my papers in order recently, I found the text of a speech I gave in December 2005, just a few days after resigning as vice-president of the Montreal Economic Institute to run as a candidate in the federal election that took place in the weeks thereafter. The event was a debating contest among students organized by the Canadian University Society for Intercollegiate Debate at Bishop’s University in Sherbrooke, Quebec. I spoke about the importance of defending the right ideas and discussed one idea in particular: the threat to individual freedom arising from the growth of government. — 31 July 2009

The growth of government in the 20th century and the importance of debating ideas

By Maxime Bernier
Bishop’s University

December 3, 2005

In public debates, it is easier to be on the side of conventional wisdom than to defend controversial ideas. I will try the difficult road. I will defend an idea that is not very popular among mainstream intellectuals, students, and academics.

When something is wrong, we need political leadership, we need a government program. Right?

In fact, this is not the sort of idea I will defend. It is too consistent with the general assumption that the government should do something whenever somebody sees a problem somewhere.

Tonight, I will defend the opposite idea. As a lawyer by profession, and somebody who worked until recently with economists at the Montreal Economic Institute, an independent think tank, I am too aware of the problems that government intervention creates in social relations.

Public debates are at the heart of what the Montreal Economic Institute does. They often start debates on topics on which the politicians don’t want to talk.

Recently for example, the Montreal Economic Institute published a study showing how a government monopoly on alcohol distribution – like the Société des alcohols du Québec or the Liquor Control Board of Ontario – is inefficient from whatever point of view one looks at it. Except, of course, from the point of view of the busybodies, and of those who have an interest in the status quo.

Public debates are important because they are one crucial means to find the truth. I say “one” important means because talking is not sufficient. It is also important that individuals be free to live in accordance with their ideas and their values. The status quo, the old ideas, need to be challenged. Especially today, with political correctness all around us.

One thing that public debates can shed light on is not the difference between the mixed bags called “the left” and “the right,” but between people who, whether in the social or the economic field, argue for more or less government.

The century of the state

Benito Mussolini was the author of the article on “Fascism” in the Italian Encyclopaedia of 1932. He wrote:

For if the nineteenth century was a century of individualism, it may be expected that this will be the century of collectivism and hence the century of the State.” (Reproduced in Internet Modern History Sourcebook, Fordham University,http://www.fordham.edu/halsall/mod/mussolini-fascism.html.)

The problem is that Mussolini’s hopes have been realized. The 20th century was the century of the state. In all countries of the world, the government’s role and power increased dramatically. If we use the admittedly imperfect measure of public expenditures, their average ratio to gross domestic product in the main countries of the free world doubled from 1913 to 1960 (from about 13% to 28%), and went up again to 46% in 1996. Public expenditures in Canada have followed the same trajectory. (Vito Tanzy and Ludger Schuknecht, Public Spending in the 20th Century: A Global Perspective, Cambridge: Cambridge University Press, 2000, pp. 6-7.)

If we look at public expenditures per capita in constant dollars since 1961 in Canada, we get a clearer view of what has been happening lately. Real public expenditures per capital (all levels of government) have tripled from less than $4,000 in the early sixties to about $13,000 in the mid-1990s. After declining to $12,000 in the late 1990s, they are on the rise again.

Thus, there has been no reduction in the size of government, but only a levelling, apparently, temporary, of its growth.

Now, public expenditures, and the taxes that go with them, only provide one aspect of the growth of the state. Another aspect is the evolution of regulation. On this front, the picture is the same, or perhaps slightly bleaker.

The Montreal Economic Institute has calculated that the Quebec government now adopts some 8,000 pages of new laws and regulations every year, while the federal government tops this with another 2,000 pages. In Canada, like in other countries, the creation of new laws and regulations slowed down a bit in the 1980s, but this was only temporary. In fact, very few regulations have been abolished, while a host of new ones have been imposed. We are a more regulated society than at any time in our history.

Why has government grown so much?

Why did our democratic governments grow so much? Why was the 20th century the century of the state? Did everybody really want such monstrous governments, probably more powerful than any monarchical government in western history?

These questions have been addressed by Public Choice economists during the past few decades. Those of you who are studying economics or political science know that Public Choice is a school of economic analysis, developed by thinkers like Anthony Downs, James Buchanan (the 1986 Nobel laureate), and many others. Public Choice has now become part of mainstream economic analysis.

The starting point of Public Choice theory is the rather realistic assumption that politicians and bureaucrats are not less selfish than ordinary people like you and me. This is why we have “government failures,” the failure of the political and bureaucratic system to satisfy the preferences of voters and deliver efficiently what they want.

There are many reasons for this. Let me try to summarize them by referring to what Milton Friedman, the 1976 Nobel economics prize winner, called the “iron triangle” of politicians, special interest groups and bureaucrats.

Politics is often driven by small concentrated interests who win the support of politicians against more important but dispersed and unorganized interests. Thus, the special concentrated interests win against the larger but dispersed interests of the taxpayers. We observe this in the case of government subsidies and all forms of protection that are granted to commercial enterprises.

This is why so many people obtain privileges from the government, and we all end up paying for this, whether we want it or not. If you add all similar instances, you get governments that take and spend 45% of what people earn.

One reason is that, as Public Choice economists say, the voter remains largely ignorant of politics. The typical voter spends less time researching political and economic issues than inquiring about the car he buys. Consequently, the politicians will respond to the demands of special interests more than to the general voters’ preferences.

Finally, consider the last side of the iron triangle: the government bureaucrat. Have you ever seen a government bureaucrat begging to make sacrifices to serve the public – for example, by requesting a lower salary? Not exactly. The government bureaucrat is neither bad nor good. He is just like you and me, that is, he is mainly interested in his own welfare.

The typical government bureaucrat will try to get more income and perks. If he has some influence on the political decision process, he will try to expand the programs he administers. And, in fact, bureaucrats, except at the lowest levels, do have much impact on the political decision process because they control the information and the agenda of the politicians.

If both special interests and bureaucrats want more government and politicians respond positively to them, voters get more government whatever they want. This is the real life, the state as it is, and not as it should be in some people’s dreams.

Out of control government is a systemic problem. Every year, the Fraser Institute calculates when Tax Freedom Day falls, that is, when the average Canadian stops working for all levels of government (federal, provincial and municipal) and starts keeping for himself what he earns. This year, that day was June 26. In a sense, we are slaves of the governments for six months and free the other six months: we are forced to pay taxes, and these taxes are used to control us and to solve the problems that were created by too much government.

The practical consequences

The practical consequences of governments taxing and subsidizing, monitoring and controlling virtually everything are less individual liberty and less economic prosperity. It should be quite obvious that wild government intervention does not produce prosperity. If it did, Quebec would be the wealthiest region in North America. In fact, in terms of gross domestic product per capita, Quebec occupies the 55th rank among the 60 states and provinces.

Alberta is the wealthiest province, and this is not because of oil. There is no oil in Switzerland, and a lot of it in Nigeria. In fact, Alberta’s gross domestic product per capita is higher than Texas’s. Lower government intervention in Alberta quite certainly has something to do with this.

There are many economic studies showing that less government intervention means more prosperity. One of them in particular analyzed 23 OECD countries over a period of 36 years and found that larger government spending reduces economic growth. For every 10 percentage point increase in the size of government relative to gross domestic product, there is a permanent reduction in economic growth of 1 percentage point per annum.

Government cannot control the economy without controlling people. Big, fat, interventionist government affects individuals – you and me – not only through its impact on economic prosperity but, more directly, through the loss of control of individuals over their own lives.

Individual sovereignty is undermined when adults must, like children, ask the government for myriads of authorizations and permits, often for activities that used to be completely free until a few decades ago.

What will come next? Should the government dictate what people will eat and when they will exercise? Should the government impose a special authorization to people who want to have children as some philosophers and public health specialists have been proposing? Why not? Adoption is already regulated, isn’t it? All this, for our own good, of course. If we believe Public Choice theorists, it seems that we are going right into George Orwell’s novel, 1984.

As I said at the beginning of this address, the real division is not between left and right, but between statists and defenders of individual liberty.

There is hope

I still think that there is hope. We are not condemned to have more and more powerful government and less individual liberty.

There is hope, if you believe in yourself. If you believe in your right to control your own destiny and plan your own life. If you act as a citizen, not as a beneficiary. As a citizen, not as a spectator. As a citizen, not as a subject. As a responsible citizen.

Our fellow citizens need to be persuaded that their individual liberties are being threatened by government tyranny. It will not be easy, but it can be done.

The fact that the growth of government has slowed in the 1990s supports my hope. One reason why I am optimistic is that I believe in the individual. Individuals will start again demanding the respect of their sovereignty. Individual sovereignty is what is important – not sovereignty of the state. Indeed, the sovereign state is, by its very nature, a steam-roller of the individual.

Thus the intellectual and moral battle of the 21st century is between those who favour liberty versus those who favour government control of peaceful activities.

I will end by quoting two economists who were, in many ways, at opposite ends of the political spectrum. One was John Maynard Keynes, the economist whose 1936 book, The General Theory of Employment, Interest and Money provided, for many decades, a powerful justification for government intervention in the economy. The other one is Friedrich Hayek, who opposed Keynes’s theories from the very beginning.

Both Keynes and Hayek thought that debates and the exploration of ideas were important, which is the point to which I wish to come back for my conclusion. Keynes wrote, at the end of his General Theory:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else.

Hayek wrote:

We must make the building of a free society once more an intellectual adventure, a deed of courage. (…) If we can regain that belief in the power of ideas which was the mark of liberalism at its best, the battle is not lost. (“The Intellectuals and Socialism”, 1949)

Everything that happens in our society is the result of the people’s actions guided by their ideas. We must fight wrong ideas and replace them with better ideas. People’s ideas and only people’s ideas can bring light where there is darkness. That’s why debating is important!

I am confident that better ideas will be spread by your generation. In the last resort, it is you who will decide if we will have a more prosper and free society.

Ladies and gentlemen, dear friends, congratulations on this event, and long live individual liberty!

Published on May 11, 2016

Two months ago, I posted a video message to support the idea of a flat rate income tax. In it, I mentioned the short book I wrote about this topic that was published in 2003. It is now available (in French only) on this blog. It offers the main arguments for the implementation of a flat rate income tax in Quebec and aims to refute the myths that sustain the current progressive income tax regime.

You can read it by going to the French version of this blog (click “Français” at the top of the page”) or you can download the PDF version here.

Published on May 11, 2016

Liberty and Responsibility: Two Fundamental Concepts
21 August 2009

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On the masthead of my blog, you can read two words: “liberty” and “responsibility.”

These two concepts are the most important ones in my political philosophy.

I believe they are the foundation of a peaceful and prosperous society. They are necessary conditions for order and progress. They are the very basis for civilisation.

Those of you who already know me have often heard me talk about individual freedom and free markets.

As I noted in a recent video message about the ideological notions of left and right, when we debate an issue of public policy, the alternatives are usually to have the government intervene by imposing new spending programs and regulations; or to leave individuals free to cooperate among themselves and find a solution.

I have often observed that some people fear liberty because they are afraid of its consequences. They think that if we leave people free to do what they want, it will mean some kind of free for all where anybody can do anything. For example, where people will be free to steal, or to pollute, or to do dangerous things that will bring trouble to everyone else.

In other words, they are afraid that they will be the victims of other people’s freedom. They will bear the consequences of other people’s behaviour.

But that’s not what freedom is about. A free society is always one where there are basic rules protecting everyone’s freedom and property.

You are free to do what you want with your own person and your own property. But your freedom stops where the freedom of others begins. Nothing you do should have negative repercussions on other people or on their property, unless you had an agreement with them beforehand.

Freedom does not mean doing what you want and unloading all the consequences on the rest of society. On the contrary, to be free necessarily means that you have to be responsible for your actions.

So when we discuss government intervention, we absolutely have to take this into account. Ideally, governments should intervene as little as possible so that individuals are free to act as they want. But governments should also protect the rights and property of all citizens, and enforce agreements and contracts.

In particular, they should not do anything that would allow people to avoid taking responsibility for their actions. For example, in an ideal world, governments should not bail out those who made bad business decisions. They should not act as a collective insurance for everyone who took unnecessary risks. They should not, as is often the case nowadays, privatize the profits and socialize the losses.

If people understood this, perhaps there would be less fear of freedom, and a better appreciation of its fundamental importance.

I believe that Canadians are intelligent and responsible people who can be trusted. They know better than any politicians or bureaucrats in Ottawa what’s good for them.

I will leave you with this excellent quote from the great economist and philosopher Friedrich Hayek:

“Liberty not only means that the individual has both the opportunity and the burden of choice; it also means that he must bear the consequences of his actions and will receive praise or blame for them. Liberty and responsibility are inseparable.”

Talk to you soon.

Published on May 11, 2016

10 September 2009

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Hi everyone,

If you follow financial news, you will have read dozens of articles and commentaries about the dangers of deflation since the beginning of the economic crisis. Deflation is the opposite of inflation. It is a sustained fall in the level of prices.

We are told that if we let prices go down, consumers will put off their purchases to benefit from even lower prices. This will reduce business activity, workers will get laid off, consumers will be even more reluctant to buy, and we will end up in a big depression like the one we had in the 1930s.

Almost everyone agrees that very high inflation is bad, but they tell us that deflation would be even worse.

This is one of the main reasons why central banks in most countries have flooded markets with new money and rescued failing banks. We had to do all we could to keep prices from going down, which would lead to a depression.

Well, there are several problems with this economic theory.

Let’s start with common sense and what’s happening in our daily lives. Do you, as consumers, prefer to buy stuff that is cheaper or more expensive? I think we all know the answer to that!

We are all consumers, and we all benefit when prices go down. If we pay less for one good, it means we have some money left to buy other goods.

Economic activity does not stop. It simply means we can buy more with the same amount of dollars. And more purchasing power means a higher standard of living for everyone.

In fact, there is nothing mysterious about the effects of lower prices. Think about computers.

Fifteen years ago, they were big, not very powerful, had few gadgets, and cost a lot more than today. Prices in the computer business have been going down all the time since then.

Have people stopped buying computers or waited years before buying a new one to benefit from even lower prices? Absolutely not. On the contrary, more computers are being sold as their prices go down.

But perhaps these are too anecdotal examples dealing with only a limited aspect of reality. The economy as a whole might work differently, and if you observe a sustained drop in the overall level of prices, you will get different results.

So I did a little search to try to find out what had happened in the past in periods when there was deflation.

Two economists at the Federal Reserve Bank of Minneapolis, Andrew Atkeson and Patrick J. Kehoe, did precisely this five years ago. Their paper is entitled “Deflation and Depression: Is There an Empirical Link?”

Their conclusion is quite interesting.

They examined dozens of episodes when prices went down in 17 countries over a period of a hundred years. In the large majority of cases, these were periods not of depression, but of economic growth. The only major exception is the period of the Great Depression.

This is what they conclude: “Overall, the data show virtually no link between deflation and depression.”

So! There you have it! The idea that falling prices lead to depression is simply not true historically. But it seems that almost nobody took the trouble to check the historical record.

Which makes you wonder if central banks did not overreact when they printed hundreds of billions of dollars to make sure we would not be entering a deflationary period.

Could deflation instead be a positive economic phenomenon? That’s what I will discuss in my next video message. Thanks for listening and see you then.

Published on May 11, 2016

28 September 2008

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Hello,

In my previous video message, I explained that contrary to what we hear or read every day since the beginning of the financial crisis, an overall decline in prices does not necessarily lead to an economic depression. This thesis is entirely based on the exceptional case of the Great Depression and it doesn’t fit with historical facts.

I concluded my message by asking if deflation was not instead a positive economic phenomenon. This is what I want to discuss with you today.

We all know that there is a sustained rise in prices when the quantity of money circulating in the economy increases faster than the quantity of goods and services. It’s easy to understand why. Something that is scarce is generally more valuable. But when it becomes a lot more abundant, it loses its value.

So, the more money there is, the more it drops in value, and the more consumers need to pay for the available goods. In other words, they have to give up more of these worthless dollars to obtain the goods.

This is precisely what’s been happening in most countries for the past decades. That’s because central banks never cease to create more money out of thin air, which causes prices to constantly go up. For example, they have gone up by 42% in Canada since 1990.

An overall drop in prices will occur when the opposite is happening. That is, when it is the quantity of goods and services that increases faster than the quantity of money. Also, logically, if both rise at the same rate, prices will stay more or less stable.

So, imagine a situation where central banks don’t manipulate the money supply anymore. And instead of continually rising at a rate of between 6 and 12% per year, as we’ve seen in Canada in recent years, the quantity of money in the economy stays the same.

Every year however, we become a little bit more productive. We create new goods and services. We find new methods to produce them more efficiently. Technology gets better. And if there is population growth, there’s also more people working.

So there are always more and more goods and services available in the economy, but we have the same quantity of money to buy them. Prices will obviously have to adjust by going down. If the economy grows, let’s say, by 3% a year, while the money supply grows by 0%, then we will necessarily get price deflation.

This is not just theory. It is what happened several times in the 19th century, in an era of rapid economic development. At a time when there were no central banks and when money was calculated as a certain quantity of gold or silver.

Note again the difference. Most economists and media commentators tell us that if prices go down, this will lead to some economic catastrophe. But in reality, the decrease in prices that I have just described happens precisely because we produce more things.

Deflation is not a threat to our prosperity. On the contrary, in a situation where the money supply is stable, it is the manifestation of prosperity!

Prosperity has nothing to do with the quantity of money that we have in our pockets, but rather with the quantity of goods that we can buy. And if we can buy more goods with the same amount of money because prices are lower, then we are more prosperous.

This is why there is no reason to fear a drop in prices. And why the interventions by central banks to prevent prices from going down may cause more harm than good to the economy.

The real debate that we should be having is about the constant creation of new money by central banks. Is this really necessary? Doesn’t it destabilise the economy? Who does it benefit? Don’t we get poorer when the goods that we buy always get more expensive?

I’ll have other occasions to raise these issues in future messages.

Until then, thank you for listening and talk to you soon.

Published on May 11, 2016

10 November 2009 

A journalist at the National Post, John Ivison, writes a column this morning that refers to a presentation I gave in 2004 on whether or not the creation of a federal securities commission would be in accord with the Constitution. As everyone knows, the topic has been in the news recently, when my colleague Jim Flaherty, the minister of Finance, announced that our government would ask the Supreme Court to give its opinion on the matter. This controversy has been going on for many years already.

As I told Mr Ivison when he contacted me, I haven’t changed my mind and I still believe that the Constitution allocates this power to the provinces. There is nothing secret in the position that I have defended and for those who would like to consult it, I have scanned the text of my presentation, which you can access here.

I am however very proud of the fact that contrary to what a liberal government would likely have done, our government has not imposed its legislative will on Quebec and other provinces who object to such a move and has chosen instead to ask the opinion of the Supreme Court. A conservative government will not encroach upon areas of provincial jurisdiction. This debate will be settled once and for all and our government will respect the decision of the Court and the Constitution.

One thing that is not mentioned in the article and that I would like to clarify is that I mostly became interested in this question when I worked as vice-president for corporate and international affairs at the Quebec Securities Commission (now the Autorité des marchés financiers) between 1997 and 2000. I gave the presentation a few years later at a colloquium on securities organized by the Canadian Institute in Montreal after I had become vice-president of the Standard Life of Canada.

Published on May 11, 2016

13 November 2009

Hello,

About two weeks ago, on October 27, I asked a question about the Canadian dollar to Bank of Canada governor Mark Carney who was appearing before the Standing Committee on Finance.

Over the past few weeks, Mr. Carney has stated several times that he would intervene to push down the dollar if it gets too high compared to the US dollar.

As you will see in the following excerpt, he agrees with me that there are advantages as well as disadvantages to having a strong currency. But his answer raises an interesting point about the way the Bank of Canada conducts its policy.

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Question: You have said several times that you will not hesitate to intervene if our dollar goes up too much against the US dollar.

From your declarations, we get the impression that a strong currency only has negative consequences, for exporting businesses and for economic growth in the short term.

However, a strong currency also benefits consumers by making imports cheaper; travelers who go to the United States; businesses who import equipment from the US; and investors who invest in other countries.

Also, there would be negative consequences if you intervened to prevent it. It would mean creating Canadian dollars in order to debase our own currency as fast as the Fed is debasing the US dollar. It is generally recognised that during the Great Depression, competitive devaluations made the crisis much worse.

So I would like to ask you if you agree that there are pros and cons to a higher Canadian dollar and if so, how do you proceed to make a balanced decision that takes all these factors into account?

Thank you.

Answer: Mr. Bernier is right, there are positive and negative conséquence to the strength of our currency. But what matters in the end is the impact of the exchange rate, coupled with all other internal and external factors, on global demand and the inflation rate in Canada. This is what determines the monetary policy of the Bank of Canada.

(NB: This is not a verbatim transcript but rather an adapted translation of the notes I used for my question as well as Mr. Carney’s answer.)

His answer is very clear. What determines the policy of the Bank of Canada is the impact of the exchange rate and all other factors on global demand and on the inflation rate in this country.

Whatever advantages or disadvantages there are to having a strong dollar, Mr. Carney says essentially that this is irrelevant, and only counts insofar as it affects the rate of price inflation.

As you may know, there is an agreement between the Bank of Canada and the Finance Minister to aim at a price inflation target of 2%. Right now, the price consumer index in Canada is below 0%. So, to meet its target, the Bank has to carry on a policy that will increase the rate of price inflation. One of the things it has done to achieve this goal was to drive interest rates close to zero.

This is also why Mr. Carney doesn’t like to see the Canadian dollar increase too much against the US dollar. This has the effect of lowering the price of imported goods and making business more difficult for Canadian exporters. It consequently drives down the rate of price inflation even more. Mr. Carney instead wants prices to increase faster. And so he says he is willing to intervene.

He would do this by creating Canadian dollars out of thin air and buying up US dollars with them, thereby pushing down the price of Canadian dollars on currency markets.

Now, as I have said many times in the past, I don’t believe monetary and price inflation is a good thing for our economy and for Canadian consumers. Inflation is the equivalent of a tax in that it devalues the money that we have in our pockets and bank accounts. It is true that most of us get salary increases that compensate for the loss of purchasing power. But those whose income doesn’t increase as fast as prices get poorer.

Monetary Inflation is a hidden way of redistributing wealth from some groups to others within our society. It also creates all kinds of market distortions and is the cause of the booms and busts that our economy has been going through.

The agreement on the price inflation target between the Bank and the minister of Finance is set for five years and has to be renewed next year, in 2011. I think this is a very good time to have a debate on the consequences of inflation. Should we lower the target to 1%? Or if inflation is bad, why not to 0%?

Come back to my blog if you want to hear more about this issue.

Thanks for listening and see you soon.