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The Limits of Financial Regulation

David Dodge: American-style regulation is inefficient and pushing financial activity out of the banking system

In this presentation at Queen’s University, David Dodge, economist and former governor of the Bank of Canada, offers a medium-term view of the Canadian and global economies. He sees “a continued skew in distribution of income” that will dampen economic growth, with central banks having “a rather heavy foot on the accelerator.” Dodge notes that while central banks have kept interest rates low to spur growth, regulators have increased capital requirements of banks and imposing ever more controls. Would it be better, he asks, to have higher interest rates but remove some of the constraints on the system? He suggests that Canada consider abandoning the strict rules of the global regulatory community and return to a made-in-Canada approach. Dodge is chancellor emeritus of Queen’s University.

Video Highlights

0:14     North America is now at the end of the recovery phase from the 2008-09 financial crisis, with Europe having further to go. “We still have pockets of excess supply particularly around Europe, Japan, and, surprisingly, in some emerging market countries such as Brazil and, for different reasons, Russia.”

4:26     In the medium term (2017 to 2020), “we’ll see a continued skew in distribution of income towards the higher end, and rather weaker growth of incomes in the ‘middle class’. That means that consumption per se is not going to have quite the drive . . . had income been more evenly distributed.”

8:32     On the demand side, governments have little fiscal room to maneuver, so from now to 2020, government demand will grow more slowly than GDP. On the supply side, aging populations (particularly in Japan and Germany) will restrain the labour supply and constrain economic growth. 

13:14     By 2020, the growth rate for the U.S. economy will likely stand at 2.5 percent but for Canada will run well below 2 percent. China will have “an enormously difficult transition to make from consumption representing only 40 percent of their economy to something that looks much more like the rest of the world, which means they won’t get as much kick to growth from investment.” 

17:00     On monetary policy: “The betting will be interest rates well below the period observed during 2000-2007, and central banks will tend to have a rather heavy foot on the accelerator. This makes sense in a world where we have constraints on the demand side.”

19:10     In the wake of the financial crisis of 2008-2009, central banks in developed countries kept interest rates low to generate liquidity and demand. Regulators, mindful of the excesses that led to the crisis, increased capital requirements of banks and imposed ever more controls. These forces are working against each other.  “Since 2008, the world has moved to American-style regulation, which. . . is enormously inefficient [and] pushing a lot of financial activity out of the banking system into markets which are regulated by securities commissions that historically have done an extraordinarily poor job . . . [We] in Canada will have to look hard at not following the strict rules of Basel and the global regulatory community and returning to our more principles-based regulation.”