Opinion: It’s time for the Bank of Canada to make a tough choice

The domestic political mood is too fragile to risk a sudden downturn, and the Bank must be careful not to lose public support again

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I first heard the hoax that “central bankers think inflation is always and everywhere a monetary phenomenon – except this time, of course” over 50 years ago, but it’s still like nine.

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Take the example of the Bank of Canada, now caught in a trap of its own accord. His mandate, pending imminent renewal, requires him to keep inflation within a range of around 2%, but his “forward guidance”, published unceasingly for a year, has promised to maintain the rate. overnight interest rate at 0.25% until the real economy returned to “normal” – at a date that appears to have recently moved closer to its original value towards the end of 2022. The Bank is stuck with two quantitative targets, one, an inflation target agreed with the government which is its ultimate political target, and the other, its own creation, its overnight rate target, which is its main policy instrument. And he doesn’t seem to have given much thought to what to do if they turn out to be a mismatch, which they have now. So: how did the Bank get into this mess, and above all, how is it doing?

We shouldn’t blame authorities for swiftly resorting to strong, unconventional stimulus measures when COVID-19 struck last March. Continuing with “inflation targeting as usual” under these circumstances would have been a bit like sticking to the gold standard rules in the summer of 1914. You also don’t really have to complain that the stimulus turned out to be a bit excessive – better too much than too little under the circumstances, surely? The Bank’s fault, which it shared to varying degrees with the Fed, the European Central Bank and the Bank of England, was not sufficiently appreciating the inflationary risk inherent in its measures, and even more so in the issuance of its term interest. referral rate with an unjustified degree of certainty.

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By early 2020, Canada’s broad money supply, “M2 ++”, was growing at an annual rate of about eight percent measured over the previous three months, as it had done, more or less, over the course of the year. of the previous decade. (M2 ++ includes cash, checking and savings accounts, and other types of highly liquid assets that could be quickly turned into cash.) By the end of June, it was increasing by over 20%, and although this rate fell to just over 10%. percent at the start of 2021, it has shown little sign of further slowing down until very recently.

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Surges in broad money growth do not always lead to inflation. But often they do. So whenever they occur, and especially if they show signs of persisting, policymakers need to investigate the reasons – quickly and carefully. Judging from the public record of its forecast, the Bank of Canada totally ignored the silver warnings this time around and didn’t even think it might be exaggerating the expansion a bit and that an upsurge in inflation could be envisaged for 2021. This was not alone, of course. The Fed in particular made the same mistake, if not on a larger scale, thereby ensuring that the inflation we are facing is now firmly entrenched in international and Canadian markets.

With an unnecessary fall election on the sidelines, the bank is now freer to act than it was earlier this year, and if the current “quantitative easing” run-off were to be accompanied by A first overnight rate hike at the start of the new year would be welcome. But this is not a plea for a major acceleration in monetary tightening thereafter. The damage on the inflationary front is now done and must be gradually repaired. The domestic political mood is too fragile to risk a sudden downturn, and the Bank must be careful not to lose public support.

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Above all, he must start rebuilding his credibility. To that end, its current mandate to control inflation must be renewed with strong political support and without the addition of additional bells and whistles. The Bank has already had more than enough trouble achieving a simple goal under very difficult circumstances, and giving it a more complicated mandate would only expose its reputation to the risk of further damage. And then he needs to set a clear date to bring inflation back to its target range – maybe two or three years from now – without any accompanying indication of what that might mean for the time path of interest rates. There is no way to predict this time path under the current circumstances, and the Bank should say so explicitly, as it swears the kind of forward guidance that has already caused it so much trouble.

David Laidler is Emeritus Professor of Economics at Western University and a Research Fellow at the CD Howe Institute.

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