Review of the Bank of Canada’s Exceptional Policy Actions During the Pandemic: Executive summary

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The COVID‑19 crisis was a once-in-a-lifetime shock that had profound impacts on Canadians and the economy. The extreme uncertainty caused by the crisis led to unprecedented disruptions in financial markets. Measures to curb the spread of the virus saved lives but led to widespread job losses, business closures and financial insecurity across the country.

Governments and central banks around the world took decisive action to prevent economic collapse. In March 2020, the Bank of Canada cut the policy interest rate from 1.75% to 0.25%, and launched a range of liquidity facilities and asset purchase programs to restore market functioning.  

By mid-2020, financial markets were working again, but the economy was very weak and inflation was well below target. The Bank turned to two policy tools that are reserved for the most exceptional circumstances: quantitative easing and extraordinary forward guidance. These tools provided additional support, helping steer the economy toward recovery.

This review looks at the effectiveness of the Bank’s exceptional policy actions during the pandemic. It also draws several lessons that will help shape future decisions should these tools be needed again.

Evaluating the Bank’s bond purchases to restore market functioning

The sudden closure of large parts of the economy in early 2020 created severe shock waves in financial markets. Businesses and investors rushed to sell assets and raise cash because no one knew the consequences of the virus. This generalized flight to the safety of cash froze financial markets. The Bank’s top priority was to get markets working again so that households, businesses and governments could continue to access credit.

The Bank launched several programs to stabilize markets by purchasing bonds in financial markets. The largest of these programs involved the purchase of Government of Canada bonds. These bonds serve as the benchmark for other credit markets in Canada. These programs helped restore market functioning quickly, allowing households and businesses to continue to access the credit they needed.

In the future, the Bank could be clearer about the limited circumstances under which it will conduct these kinds of large-scale asset purchases. This would help guard against moral hazard, when market participants take bigger risks thinking the central bank will step in if things go wrong. Also, the Bank could improve the programs by more clearly distinguishing between asset purchases to restore market functioning and asset purchases for monetary stimulus. The Bank should outline the purpose of each program, and it should design the programs to ensure they are temporary and have a clearly defined exit strategy.

Evaluating the effects of quantitative easing

In June 2020, after markets stabilized, the Bank continued to purchase Government of Canada bonds to provide additional monetary stimulus. This is called quantitative easing (QE). Bond purchases under QE are intended to push down borrowing rates for households and businesses when the policy rate is already as low as it can go. This supports economic growth by encouraging borrowing and spending, and helps the Bank achieve its 2% inflation target.

In October 2021, with the economy on the road to a full recovery, the Bank ended its QE program. Six months later, the Bank began to allow its purchased bonds to mature and roll off its balance sheet—a process called quantitative tightening.

Measuring the precise impact of QE is challenging. The Bank used a variety of approaches to estimate what would have happened without QE. It found the program kept longer-term interest rates lower than they otherwise would have been, thereby boosting the economy and keeping inflation from falling too far below target.

As a result of QE and the bond purchases to restore market functioning, the value of financial assets on the Bank’s balance sheet grew significantly. This exposed the Bank to interest rate risk because bond purchases were funded with short-term liabilities that pay interest, called settlement balances. Depending on how interest rates evolved, the Bank could have experienced profits or losses. In this situation, as the Bank raised the policy rate to fight inflation, it saw net losses—as did other central banks that used QE. The Bank expects to return to a positive net income position by 2026, as its balance sheet normalizes, and interest rates decline.

If QE is needed in the future, the Bank could link the size and pace of purchases, as well as the end of QE, more clearly to the inflation outlook.

Because QE supports demand and helps bring inflation back up to the target, some have suggested it contributed to the high inflation that emerged later in the pandemic. However, the Bank’s analysis indicates that its policy actions—including QE—did not on their own push inflation significantly above 2%.

Evaluating the effects of extraordinary forward guidance

Extraordinary forward guidance (EFG) signals that the policy interest rate will be low for a defined period or until certain economic conditions are met. This reduces uncertainty about future interest rates and, in doing so, encourages borrowing and spending, which helps support the economy and bring inflation back to target. The Bank used EFG during the pandemic, saying the policy rate would stay at 0.25% “until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved.” It also provided an estimate of the expected timeline, adjusting it as forecasts changed. The Bank officially ended its EFG in January 2022.

When the Bank introduced EFG in July 2020, market interest rates did not move down much because expectations for future rates were already low. Still, EFG may have kept expectations for future rates from rising. Thus, by reducing uncertainty, EFG likely boosted overall demand.

A risk with EFG is that efforts to communicate it as simply as possible can lead markets or the public to interpret it as a broader guarantee than intended. And if a central bank does not follow what it is perceived to have said, it can be accused of breaking its promise. So, if the economy improves faster than expected, a central bank can be forced to choose between ending EFG earlier than was understood or leaving it in place for too long. In the future, the conditions of EFG could be more clearly tied to the inflation outlook and emphasized more often in communications.

The Bank is committed to being transparent—and to learning from the experience of the pandemic. The next crisis could look quite different. Taking on board the lessons outlined in this review will ensure the Bank is better prepared for future crises.