Qualicum Institute: Advocating a science-based understanding of ecological, social and economic survivability


Government Borrowing,
Inflation, and the Bank of Canada

Government borrowing from the Bank of Canada (BoC) to finance its investments and deficits has been declared as inflationary and a policy to be avoided.1 This is a myth, unsupported and unsupportable by Canadian facts, history, and logic. Canadian experience with borrowing primarily from the BoC in the period 1938 to 1974 shows no demonstrable inflationary influence from such borrowing. Not a myth is that the shift to government borrowing primarily from private sources in 1974 has led to an exponentially-growing federal debt burden currently at over $1.192 (July 2023) trillion and growing by about $235 million every day.2 It is time for politicians and the Government of Canada to face up to this reality and begin once again to use the Bank of Canada to finance government investments at zero interest.

Over the past one hundred years Canada has experienced three periods of anomalously high (over 10%) inflation.3 The first was during World War I when government expenditures on armaments greatly increased the circulating money supply, creating a demand-pull inflation of about 11% from 1916 to 1920. During World War II, inflation was held in check, probably because of price controls and  rationing imposed by the government.4

The second occurred briefly after World War II in 1947-8 at a rate of 12%. This was another demand-pull inflation most likely caused by the return of armed forces and the lifting of price controls as the economy adjusted to post-war conditions. Thirdly, in the period 1973-1982, Canada experienced a prolonged period of inflation averaging 11%. This was a classic cost-push inflation caused by the OPEC oil crisis when oil prices were raised.5 Interestingly these anomalous periods of Canadian inflation were paralleled by similar spikes in US inflation.6 The causes and effects were not uniquely Canadian.

Over these periods, government borrowing of fiat money to cover deficits may have contributed to monetary expansion and the consequent demand-pull component of all inflation (high, low or moderate). However, it is clear that whether government borrowed fiat money created by the BoC or borrowed from private lenders, it made little difference to inflationary rates. Note that government borrowing7 of fiat money from private banks represents only a small portion of actual borrowing. Most borrowing is sourced from non-fiat: private savings, insurance reserves, pension funds, and foreign investors.

The BoC was created in 1934 by the Government of Canada (GoC)8 partly as a response to the great depression. Beginning in 1938 the GoC nationalized Period of wealthand began financing its deficits by borrowing from the BoC at a zero interest rate. The BoC provided this money by creating it as a simple book entry.9 That is to say the money was created from “thin air”. By taking this money and spending it into the economy, the GoC was increasing the money supply.

The GoC was able, in part, to use this mechanism to finance Canada’s recovery from the depression, our efforts toward winning World War II, Universal Health Care, and many of our major investments in infrastructure—the St. Lawrence Seaway, our international airports and other transportation infrastructure. In fact, it helped lead Canada’s greatest period of growth in prosperity. Canada’s national debt was relatively small and not all of it subject to interest charges.

In 1974, the GoC at the urging of The Basel Committee,10 decided to privatize its borrowing, financing most spending deficits by borrowing from private lenders at prevailing interest rates. Private banks provide the funds they lend to government (or anyone else) in exactly the same way as does the BoC. They create it out of “thin air” and therefore increase the money supply. Since 1974, Canada’s national debt has spiraled upwards, driven by compounding interest charges to the point where today interest on the debt is equal to the cost of public education.11

The privatization of government borrowing was implemented on the pretext that interest-free borrowing by governments was inflationary because it was financed by creating new fiat money through the BoC. Therefore the money supply would be expanded and that would lead to inflation. (As of March 31, 2012, domestic investors held about 75 percent of GoC securities.12 Thus, the majority of the national debt is money that the GoC owes to Canadians. Among domestic investors, insurance companies and pension funds hold the largest share of GoC securities—23.3 percent—followed by other private financial institutions, 13.8 percent, and chartered banks and quasi-banks, 12.1 percent. Taken together, these three categories account for about half of outstanding GoC securities [debt].) The BoC currently holds about 9% of the federal debt.

So let’s examine the relationship between government borrowing and inflation in Canada. In the thirty-seven year period before privatization (1938–1974) Canada’s average rate of inflation was 3.5%.13 As a comparison the USA’s rate of inflation was 3.5%14 while the USA was financing its deficits through private borrowing. In the forty eight year period after privatization (1975–2022) Canada’s inflation averaged 3.6%. The comparable inflation rate in the USA was 3.8%. When one considers that the Canadian economy and inflation rate closely parallel the USA in most aspects, it seems clear that privatization of government borrowing caused no appreciable rise in Canada’s rate of inflation. Meanwhile interest charges have built up a national debt burden that limits the ability of governments, both federal and provincial, to provide value to taxpayers for the taxes they pay.

Modest inflation of around 2% has long been a managed target15  of the Canadian government. A key responsibility of the BoC is to manage this low level of inflation primarily by setting the overnight bank interest rate. Controlled inflation is regarded as a tool in stimulating and managing the economy and is nothing to be feared.

What is to be feared is uncontrollable, runaway, hyperinflation defined as sustained rates over 50% per month.16 Hyperinflation is not uncommon, with more than 30 countries17 having experienced its devastating effects over the last 100 years. In virtually every case, these countries experienced economic collapse caused by extreme mismanagement, revolution, or political upheaval. Governments responded to collapse by attempting to stimulate their economies through the release of ever-increasing amounts of the national currency in an effort to boost consumption. Too much money chasing too few goods drove up prices in a self perpetuating spiral as the value of currency collapsed. Governments experiencing huge deficits used currency expansion to pay for their deficit spending without attaching the new currency to real productive economic activity such as new infrastructure construction. In such circumstances, government leaders had unfettered access to money creation and used it in a profligate, undisciplined, short-term effort to save themselves and their regimes.

Never in recent history have countries with democratically controlled stable governments experienced hyperinflation and this is key to our proposition for Canada. In Canada’s case, government profligacy is protected-against within the Bank of Canada Act18  which has safeguards built-in (see Sections 18 i and j): e.g., Section 18 j—the loans outstanding at any one time shall not exceed one-third of the estimated revenue of the GoC for its fiscal year, and such loans shall be repaid before the end of the first quarter after the end of the fiscal year of the government that has contracted the loan. Other safeguards could be enacted as and when needed.

The essence of this is that an increased money supply, borrowed from the BoC, when invested into real productive economic activity within the available resource and manpower capacity, is not inflationary. It creates neither cost-push nor demand-pull inflationary pressure. Furthermore, when the loan is repaid to the BoC, as it must be, the money supply contracts as this money returns to its source,”thin air” or as the economists like to say, the money goes to money heaven.

The essence

Canada has developed a huge debt burden over the years since 1974. It is costing taxpayers over $180 million per day (2022/2023) in interest payments for which Canadians have received and do receive no commensurate service. It is a transfer of each Canadian’s hard-earned wealth to a minority of others—including foreign investors—as a consequence of a misguided government decision made over 40 years ago. It must be acknowledged that the debt does exist, must be paid, and Canada’s obligations honoured. However, we propose that in future, the Government of Canada begin to use the institution of the Bank of Canada to finance, at zero interest rate, all its infrastructure investments. With existing or newly instituted regulatory constraints this proposal will save taxpayer money, provide valuable assets to Canadians, and have no deleterious effects on inflation.


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