Patrick Grady
"Straight, Hardhitting Talk from a Former Governor of the Bank of Canada:
A Review of Making Money: An Insider's Perspective on Finance Politics, and Canada's Central Bank by John Crow,"

March 12, 2003.

"Since I have become a central banker, I have learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said." Alan Greenspan, Chairman of the U.S. Federal Reserve Board as quoted in the Wall Street Journal.

During his seven-year term as Governor of the Bank of Bank of Canada, John Crow always spoke clearly for a central banker, even if his speeches bore the marks of drafting by committee. In Making Money Crow shows that, when freed from the shackles of centralbankese, he can write with a plain style that is a real pleasure to read, provided of course that you are not on the receiving end of his biting wit.

This book provides the most frank inside account of the workings of a central bank since the 1954 publication of Emile Moreau's Souvenirs d'un Gouverneur de la Banque de France, which recounts the history of the stabilization of the franc following its World War I inflationary decline. Crow's book is destined for similar status as a cult classic among central bankers, but it also deserves a wider readership among those interested in monetary policy.

Making Money is not a memoir in the traditional mode. In his book talks, Crow is quite contemptuous of what he calls the "Country Living" approach to central banking such as was epitomized in the January 2003 Report on Business Magazine profile of current Bank of Canada Governor David Dodge. In contrast, Crow takes pride that his book provides a serious treatment of the Bank of Canada and monetary policy and does not gloss over the hard, controversial technical issues at the heart of monetary policy.

The main theme of Making Money is how the Bank fits in to the monetary policy decision-making framework. Unlike past Governors who vanished into closed-lip retirement at the end of their terms, Crow does not hesitate to criticize the Bank of Canada and the government's current approach to monetary policy when they fail to meet his high expectations.

Crow's distaste for colorful personal exposÚs notwithstanding, a few words on how he came to be Governor of the Bank of Canada help to understand the man. Born into a working class family in the Cockney east end of London, he won scholarships first to Parmiter's, a good grammar school, and then the Balliol College Oxford, Adam Smith's alma mater, where he studied philosophy, politics and economics. Crow's first job was in the Western Hemisphere Department of the International Monetary Fund in Washington, D.C. Working on Latin America, he learned first hand about the links between government profligacy and inflation and the damage that it can wreak on an economy. Transferring to the North American Division and subsequently becoming its Chief, he visited Canada regularly as part of the team assessing Canada's economic prospects and policies. Senior staff at the Bank of Canada were so impressed with Crow that in 1972 they offered him a job as Deputy Chief of the Research Department. Rising quickly through the ranks, he took office on the next to top floor of the Bank's art deco temple enshrined between two glass towers on Wellington Street as the Bank of Canada's fifth Governor on February 1, 1987.

In Making Money Crow rigorously applies logic and economic analysis to the Bank of Canada and monetary policy. Starting with a clinical dissection of the purpose of the Bank as set out in an "artfully worded" "single sentence of fully 80 words, without even a semicolon" in the Bank of Canada Act, he concludes that it does not answer the obvious question of "What is Canada's central Bank supposed to achieve?" but instead gives a "menu of general answers." In Making Money Crow gives a more direct answer, namely that the Bank should preserve the domestic value of the currency or ensure the stability of prices.

Crow advanced the monetary policy objective of price stability in a series of speeches after being appointed as Governor with the fullest statement in his Hanson Lecture at the University of Alberta in January 1988. A misconception that Crow clears up in this book is that he equated "zero inflation" and "price stability." Contrary to what his critics alleged, Crow claims he never advocated such a simple-minded approach and is well aware of the full whole range of technical questions concerning the measurement of inflation. Being cautious though, Crow is only willing to say that price stability is "clearly below 2 per cent." To him, "price stability" means not trying to use "inflation as a systematic policy" to squeeze more output and employment out of the economy.

As his "modest contribution to truth in advertising," Crow points out that his own "inflation record was not nearly as stellar" as suggested by his critics. While it averaged 4 per cent annually, it ranged between 1 and 7 per cent peaking in 1991, meaning that the Canadian consumer dollar lost 30 per cent of its purchasing power over the period.

The monetary policy episode starring in the book is the setting of the inflation targets that were announced by Conservative Finance Minister Michael Wilson in his February 1991 budget. Inflation targets were an idea first raised in its 1990 Annual Review by the former Economic Council of Canada, an organization which Crow held in low esteem and for whose demise he shed few tears. While Crow is reticent about telling tales out of school, he stresses "that the initiative for introducing targets came not from the Bank but from the Department of Finance." In his view, its motivation mainly was to contain the consumer price inflation resulting from the introduction of the GST. A big concern at the time, which he shared, was the call by union leaders for 7 per cent wage increases to compensate for the GST even though the direct price impact of the GST was only expected to be 1.5 per cent.

Even though Crow was willing to go along with the targets for reducing inflation to 3 per cent by the end of 1992 and 2 per cent by the end of 1995 (with a one-per-cent band on either side), he dug in his heels and insisted that the commitment to price stability in the joint release had to backed up by a commitment that "went beyond words." Hence that's how the release came to include a statement that operationally "price stability" meant inflation "clearly below 2 per cent."

The Bank of Canada under John Crow's tutelage was successful in bringing inflation down to below 2 per cent in 1992 and 1993, perhaps too successful as inflation continued to fall averaging around zero in 1994.

Bringing inflation so quickly and effectively to heel was a thankless job that was not made any easier by the Conservative Government's unwillingness to rein in its ballooning deficit, and by the inflationary impact of the GST on wage demands, not to mention the Meech Lake and Charlottetown constitutional debacles, which played havoc with the Canadian dollar. During this very difficult period, John Crow's unpopularity increased with the unemployment rate, particularly among the Liberal Opposition with whom he sparred before Parliamentary committees and in other public fora.

This takes us to John Crow's final role in the inflation-target episode, which was played out following the 1993 election as his term as Governor came to an end. Crow writes that he was never asked whether he wanted to stay on as Governor, but that his silence was probably taken as an indication that he would be willing to stay. He met with Finance Minister Paul Martin twice before the situation came to a head. Before his third meeting in mid-December, he was "told, in the first instance by a top Department of Finance emissary, that in exchange for [his] reappointment the government wanted a agreement on a modification of the inflation targets." More precisely, it wanted to drop the reference to "price stability" and "a rate of inflation clearly below 2 per cent," and to keep the 1 to 3 per cent target band. Crow countered with an offer of a .5 to 2.5 per cent target band, which had a mid-point "clearly below 2 per cent." It was rejected out of hand, effectively ending Crow's stint as Governor.

The proposed new targets were then submitted to then Senior Deputy Governor Gordon Thiessen. Following their acceptance, he was appointed as Governor. The transition was seamless, a successor had been found who was not a lightening rod for the public's animosity to the previous government's anti-inflationary monetary policy, yet who signaled to the ever-important financial market insiders that the Bank remained committed to the same policy.

Or was it really the same policy? Let's take a closer look at the December 1993 joint Bank of Canada-Government of Canada announcement on inflation targets. Its first paragraph still stresses the importance of "price stability" in the following terms:

"The best contribution monetary policy can make to these objectives [i.e. high levels of economic growth and employment] is to preserve confidence in the value of money by achieving and maintaining price stability."

The final paragraph of the agreement says:

"On the basis of the experience with low inflation over the period, a decision will be made by 1998 on the target range for the Consumer Price Index that would be consistent with price stability and, therefore, with the long run monetary policy goal of preserving confidence in the value of money in Canada."

As it turned out, a target range consistent with price stability was not subsequently established in 1998 because the Bank of Canada had to cope with the impact of the Asian Financial Crisis of 1997-98, which had hit Canada rather hard through a 20 per cent decline in primary commodity prices and through very nervous and volatile international financial markets. Consequently, this was not judged to be the best time to persuade Canadians of the need for a lower target rate of inflation. Moreover, there was a view at the Bank that it was necessary to go through a complete economic cycle in order to demonstrate to Canadians that a low inflation target was consistent with good economic performance and that it would not imply the degree of monetary restraint and extremely high interest rates such as had occurred at cyclical peaks in the 1970s and 1980s and had contributed to the subsequent sharp recessions.

Crow, on the other hand, writes in his book that he has trouble reconciling the "resolute opening declaration [on price stability] with the weakened specifics that follow." He says either it is "mere spin and the actual numbers the substance" or it must be accepted on "faith the position in the 1993 statement that 'more experience in operating under these conditions...with inflation as low as it is now...would be helpful before an appropriate longer term objective is determined'." Crow is skeptical about this as "it was not, in fact, necessary in terms of the existing target timetable to make any changes at all in late 1993."

Furthermore, John Crow is puzzled by the statement in the 1998 target announcement that "it would be helpful to have a longer period of time in which the economy demonstrated more fully its ability to perform well under conditions of low inflation before determining the appropriate long-run target consistent with price stability." That the targets were extended again in 2002 is even more baffling to him. Since "the economy had gotten stronger while inflation had been clearly below 2 per cent more often than not," Crow observes "Quite what experience was being waited for is unclear. And why it is unclear remains unclear as well."

The failure to reappoint John Crow as Governor raises some questions. Given John Crow's unpopularity among Liberals, was he ever a serious candidate for reappointment? What would the Liberal Government have done if Gordon Thiessen had been unwilling to take the job with the new targets? Remember with a $42 billion dollar deficit and nervous financial markets waiting to dump Canadian bonds and dollars, the new Government was a bit over the barrel and needed a Governor in whom markets had confidence.

A more fundamental question is whether inflation targeting constitutes a sound approach to monetary policy. It seems to have worked well in keeping inflation low and promoting good economic performance. Yet in Making Money, John Crow is very critical of the current approach, which he views as "the targets without the principles." He would have much preferred "swap[ing] targets for a clearer statement of longer-run principles" rather than "simply abandoning the long-run inflation goal" as he suggested in his meetings with Finance Minister Martin.

Crow also worries that the Bank of Canada has lost an important element of its independence now that its objectives are set by the Government of the Day, leaving it only with a much less important "instrument independence" to set monetary policy to meet inflation targets.

Crow noted that, in an article in early 2001 on the appointment of David Dodge as the new Governor, The Economist magazine referred to the inflation targets "set by Mr. Dodge's predecessors." In Crow's view, it would have been more accurate to say they were "set by Mr. Martin and his predecessors." Except for being less transparent, the situation in Canada is now like in the United Kingdom where the "Chancellor of the Exchequer hands down the targets."

But regardless of what happened when John Crow was Governor, it would be wrong to suggest that the Bank of Canada does not currently have an important input in the establishment of inflation targets or that the Governor's agreement is not essential, particularly if he were willing to resign to ensure that the targets were acceptable. Gordon Thiessen's role was obviously critical in the negotiation of the inflation targets in 1993 and 1998 and he would not have agreed if he had not been convinced that they were the most appropriate at the time. And when the "inflation-control targets" were renewed in May 2001, the Bank of Canada was an active participant in the process, preparing background documents on the appropriate targets and on whether they should be raised or lowered. The Bank found no convincing evidence that, on the one hand, "targeting inflation rates of ...less than 3 per cent could lead to significant economic difficulties" and that, on the other, "the benefits of a lower target inflation rate are large enough to justify the change to a lower target." Governor David Dodge was thus quite comfortable endorsing the joint statement announcing that "the inflation-control target range will continue to be 1 to 3 per cent" until the end of 2006 and that the Bank "will continue to aim at keeping the trend of inflation at the 2 per cent target midpoint."

Although Crow appreciates the virtues of inflation targets in "supplying transparency and focus regarding monetary policy goals," he warns against falling "into the trap of assuming any inflation target is bound to be a good one." More important than targets in improving the trade-off between inflation and unemployment in his view has been the "monetary commitment to getting inflation down and keeping it down."

Crow is concerned that there is a bias in favor of inflation stemming from "the pressures of special interests and the short-run incentives that a government faces (including perhaps our case providing now for a prime ministerial 'political legacy')." Consequently, he still sees some "salutary discipline" resulting from the process of setting inflation targets publicly and explaining them to the public.

While Crow recognizes that with the dramatic turnaround from "ballooning deficits to debt reduction" in the mid-1990s there was a "place for a monetary policy that was easy to the point of pushing the currency down," he argues that it is "a bad idea to have a policy promoting currency decline." His record speaks for itself. When he took over as Governor in February 1987, the Canadian dollar was worth 74.6 cents U.S. and when he completed his term, it was worth 75.9 cents.

The Liberal Government comes in for some of Crow's sharpest verbal barbs. He asks if its statement about monetary policy in the Red Book, which counts on economic growth and fiscal responsibility to "make possible a monetary policy that produces lower real interest rates and keeps inflation low, so that we can be competitive with our main trading partners," was "a joke." After tearing its meaning apart word for word, he concludes that he is "probably in danger of having too much fun getting his gums into material that is newspaper thin." He sarcastically contrasts the ambiguity of the monetary policy statement with the clarity of the Red Book's promises to "replace the GST," "renegotiate the FTA," and establish an "independent ethics counselor." While the jibes about the GST and the FTA do not seem entirely fair to those of us who take comfort from the Harmonized Sales Tax initiative and the NAFTA labour and environment side agreements, they certainly reveal Crow's instinct for the jugular.

Other issues that Crow covers in Making Money include the exchange rate, dollarization, the stability of financial system, the coordination of fiscal and monetary policy, the history of the Bank of Canada, and monetary policy in the 1970s and 1980s.

John Crow left his successors at the Bank of Canada an important asset, a high degree of credibility for its monetary policy. This has allowed Canadian interest rates to decline to U.S. levels or even below and been an important factor behind the good economic performance of the last decade. With consumer price inflation already near 4 per cent and still on the rise, Making Money provides good advice on how not to blow it.

of an abridged version of this review that appeared in Policy Options, April 2003.