- Central bank and government set to renew five-year agreement
- High bar for change to inflation-target regime, Wilkins says
Canada’s central bank, the Group of Seven’s longest-serving inflation-targeter, is acknowledging monetary policy alone can’t solve current economic challenges as it prepares to renew its own mandate in coming weeks.
In a speech Wednesday, Senior Deputy Governor Carolyn Wilkins outlined in detail the limitations that central banks face in a low-growth environment, and highlighted the need for governments to do more to promote growth with additional fiscal stimulus and structural changes.
“We shouldn’t count on monetary policy to solve everything,” Wilkins said Wednesday in London.
The comments come in the final stretch of negotiations with the federal government on whether to renew the Bank of Canada’s 2 percent inflation targeting regime, with hardly anyone expecting any major changes before the mandate expires at the end of this year. That’s because waning effectiveness of monetary policy suggests few benefits from regime change, while potential drawbacks could be huge.
“I don’t think monetary policy is fundamentally broken” in Canada, said Christopher Ragan, a McGill University professor in Montreal and a former adviser to the central bank and finance department. “Maybe we just have to suck it up and get used to a little bit of slow growth.”
Asked about the inflation target, Wilkins said “the bar is pretty high to change something for Canada.”
The effectiveness of inflation targeting, now a worldwide standard, has been thrown into question as countries struggle to meet their targets even with interest rates at historical lows. Canada’s inflation rate hasn’t exceeded the central bank’s goal for almost two years, averaging 1.5 percent over the last five years. That’s the biggest gap relative to target since the policy was adopted in 1991 -- including the period around the 2008 global financial crisis.
Central bank failure to stoke growth and meet inflation targets has raised some calls for change. U.S. Federal Reserve Bank of San Francisco President John Williams last month called for studying options such as a higher inflation target, which theoretically would give a central banks more room to be aggressive with looser monetary policy to counter slow growth.
Bank of Canada Governor Stephen Poloz has kept the Bank of Canada’s benchmark interest rate unchanged at 0.5 percent for more than a year, even as the economy contracted last quarter and monthly trade deficits reached records. That’s because the bank anticipates the economy will return to its target of 2 percent within the next two years.
Even Wilkins acknowledged there could be benefits to raising the inflation target. It would reduce the chance of getting stuck at the lower bound on rates, and “grease the wheels” of the labor market when demand slows and workers resist wage cuts, Wilkins said Wednesday.
Still, a renewal of the 2 percent target in Canada would be seen globally as an important vote of confidence for the policy. Canada -- the classic small, open economy -- has been a harbinger of major changes in the global monetary system, from inflation targets to floating exchange rates.
Poloz has said the success of inflation targeting can’t be ignored. Since taking office in June 2013, Poloz has maintained his view that low-for-long interest rates, in spite of their diminished power, can get inflation back on track.
Former Bank of Canada Governor David Dodge agrees. “Inflation targets have served us well and indeed the principle of the inflation targets I think works equally well going forward,” Dodge said this month.
Prime Minister Justin Trudeau’s government seems to be putting much of the blame for Canada’s under-performing economy not on monetary policy but on fiscal policy, which has been contractionary in recent years.
“When you look back and say that the bank has performed in a certain way, it’s important to recognize the bank has not always had the supportive actions of the government to get to the right conclusions,” Canadian Finance Minister Bill Morneau said in an Aug. 30 interview in Hong Kong.
The Ottawa-based bank can still boast of having the fastest inflation gains in the G-7 and a near-perfect record, 1.9 percent, over two decades, all without negative rates or major asset purchases that have drawn questions about monetary policy from Frankfurt to Tokyo.
And there are costs to changing the mandate. One is the loss of credibility, said John Johnston, chief strategist at investment manager Davis Rea Ltd. in Toronto.
“You raise the target once and you lose credibility because you will raise it again,” he said. There is also political risk in opening up the central bank’s operations in a time of global populism, Johnston said.
Another cost is potentially unwanted inflation down the line, which may be the biggest reason why the Bank of Canada will stick to the status quo.
Central bank reviews of their targets will come back to the idea that “higher inflation generally speaking is associated with more unpredictable and more variable inflation,” said Steve Ambler, an economics professor at the Université du Quebec à Montréal and former special adviser at the Bank of Canada.