A Tale of Two Countries and Two Booms, Canada and the United States in the 1920s and the 2000s: The Roles of Monetary and Financial Stability Policies

The paper examines the experience of Canada and the United States in the run-up to the two biggest financial crises in global history, in the 1920s and 2000s, and the roles of their monetary and financial stability policies. Comparing the Canadian and the U.S. experiences over the two periods is instructive because Canadian monetary policy was somewhat more conservative than U.S. monetary policy and there were important institutional differences in the two periods: Canada did not have a central bank in the 1920’s and followed different financial stability policies in the 2000’s. We present evidence that suggests two conclusions. Firstly, a more moderate Canadian monetary policy in the two booms affected Canada’s relative macroeconomic performance during the booms; in particular, the extent of the economic expansion was less. Secondly, this difference, however, by itself, does not explain why Canada fared better in the recent crisis, but not in the Great Depression. Indeed, the comparative evidence suggests that it was the difference in the effectiveness of financial stability policies, primarily financial regulation supervision with respect to banks and housing finance, that explains the better Canadian performance during the recent crisis. In contrast, in the 1920s, both countries lacked the financial policies to control excess credit growth and both suffered as a consequence. In addition, both countries made policy mistakes in aftermath of the stock market crash and credit collapses; in particular, Canada pursued inflexible interest and exchange rate policies that aggravated the economic downturn.