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Lessons from our support of financial markets in tough times

Deputy Governor Toni Gravelle talks about how the Bank of Canada supported markets during the COVID-19 pandemic and what we might do differently in the future. He also discusses recent turmoil in the banking system in the United States and overseas.

Watch Deputy Governor Gravelle speak at the National Bank Financial Services Conference. Read the full speech.

An unusual crisis, an unusual response

When the COVID-19 pandemic hit three years ago, uncertainty gripped financial markets.

Markets froze because most people wanted to sell assets, but few wanted to buy them. People were even steering clear of Government of Canada (GoC) bonds, which are typically considered as safe as it gets.

The Bank of Canada has a mandate to promote the stability of the Canadian financial system. To address the stresses in key markets, we quickly put in place several programs to get markets working properly again. That allowed households, businesses and governments to continue to access credit.

Now we’re reviewing those programs so we can respond effectively to future crises.

After the global financial crisis, we learned a lot by carefully reviewing the effectiveness of our response. That work helped inform our response to the pandemic, just as the work we are doing now will help us respond better to future crises.”

Tailored support for financial markets

Our extraordinary support for financial markets early in the pandemic was essential for keeping the financial system working and strengthening the economy.

But when we provide this type of support, we must guard against moral hazard—the idea that if we step in to address one crisis, we’ll also solve other problems markets face. When moral hazard sets in, investors feel more comfortable taking greater risks.

We can avoid moral hazard by: 

  • supporting markets only at times when the whole financial system faces funding issues
  • offering support at a cost that would be unattractive in normal times
  • giving support programs short life spans and pre-set end dates
  • designing programs so they end automatically once the issues have been resolved

The COVID-19 pandemic was certainly unprecedented, and it merited a strong response from the Bank. Let me re-emphasize that this level and type of intervention should not be expected with every episode of market turbulence in the future.”

Return to a normal balance sheet

Once markets were working normally again, we shifted our focus.

We kept purchasing GoC bonds, but we were doing so to support monetary policy instead of to help markets function. That’s a process that economists call quantitative easing (QE). It lowers long-term interest rates when the policy interest rate is already as low as it can go, which helps the Bank achieve its 2% inflation target when inflation is below target.

In hindsight, we could have communicated that shift to QE more clearly. If a similar crisis occurs in the future, we will clearly distinguish between asset purchases for market functioning and those for monetary policy.

To return our balance sheet to normal, we followed QE with quantitative tightening. This process involves letting GoC bonds roll off the balance sheet as they mature.

An eye on global banking stresses

The global banking system has been facing a lot of stress lately, particularly involving some institutions in the United States and Europe.

The safeguards put in place since the 2008–09 global financial crisis make it easier to help troubled institutions while reducing the risk to the global economy.

In Canada, our financial system is well regulated and supervised, with sound risk management.

We could still be affected by events abroad because the global economy is so interconnected. So, we’re ready to act and support the Canadian financial system if markets face severe, widespread stress.

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