Canada to Reject World’s Only Price-Level Target, Survey Says
Bank of Canada Governor Mark Carney and Prime Minister Stephen Harper will probably keep the central bank’s mandate of targeting inflation at 2 percent, rejecting alternatives, including the world’s first price-level objective, according to economists surveyed by Bloomberg News.
Seven of 11 economists polled from Sept. 22 to Sept. 29 said the bank’s goal will not change when it comes up for renewal by the end of the year. Since 2006, the last time the matter was considered, the central bank said it would study pegging the level of the consumer-price index instead, as well as reducing the inflation target and using policy to counter asset-price bubbles.
Canada led the Group of Seven by adopting an inflation rate target in 1991, a policy now used by about two dozen central banks, including the Bank of England and the European Central Bank. The renewal comes as many central banks focus on weak economic growth over price gains.
“At times like this, you don’t want to introduce new uncertainty,” said Craig Wright, chief economist at Royal Bank of Canada, the country’s biggest bank by assets. “It’s not broke, so why fix it?”
Canada’s central bank currently aims to keep inflation at 2 percent, the midpoint of a 1 percent to 3 percent target range. To judge future price trends, the central bank looks at a core inflation rate that excludes eight volatile items such as fruit and gasoline.
Inflation has averaged 2 percent since the bank adopted targets in February 1991, compared with an average of 6.9 percent during the previous 15 years, according to data compiled by Bloomberg.
The Bank of Canada can influence economic growth and inflation by changing its target rate for overnight loans between commercial banks. The interest rate influences the prime rate that commercial banks charge their best customers.
Harper said in a Sept. 21 interview in New York he was reviewing the file and didn’t expect major changes. Deputy bank governor John Murray said in an August 2010 speech the benefits of a price-level targeting system could be lost “if the learning curve is too long,” and that the success of the current policy “represents a relatively high bar against which any future changes must be judged.”
Economic theory suggests targeting the level of the consumer-price index may allow people to more accurately predict prices over longer periods. The theory has only been deployed in Sweden during the 1930s to help stop deflation, according to a 1998 paper by Claes Berg and Lars Jonung of Sveriges Riksbank, that country’s central bank.
‘Play It Safe’
“There is that sense of credibility that has been built up over many years” with the 2 percent target, said Sebastien Lavoie, an economist at Laurentian Bank Securities in Montreal. “Nothing ensures a smooth transition between one target and another. It’s better to play it safe.”
The bank’s research on a price-level target included simulations done with Montreal university students led by Deputy Governor Jean Boivin, who has co-written papers with U.S. Federal Reserve Chairman Ben S. Bernanke.
Boivin said in an Aug. 23 speech that monetary policy can’t be “dogmatic” or “follow mechanistic and simplistic rules.” Boivin also said global policy makers have focused more since the 2008 credit crisis on whether to broaden their mandates to help build a more stable financial system.
“I don’t think it would be that radical a change” said Rudy Narvas, a senior economist with Societe Generale SA in New York. The Bank of Canada has already expanded a semi-annual report on financial system risks, he said.
“It’s giving them more credibility to say that they have more power to do it if necessary,” Narvas said.
Four economists in the survey predict the renewed inflation mandate will include language on promoting financial stability. The bank’s mandate may be tweaked to let it return inflation to target more slowly when there are risks to the financial system, the Globe and Mail newspaper said yesterday, citing a review of Carney’s public comments.
The successful use of a price-level target could promote financial stability by convincing businesses and consumers the central bank will act to avoid long periods of falling prices.
“There are potential benefits to price-level targeting,” Carney told the House of Commons Finance Committee in October 2010. “It is a powerful mechanism, potentially, to avoid deflation.”
Researchers at the Toronto-based research group C.D. Howe Institute and Former Bank of Canada Governor John Crow have said the current target is too loose. The cost of living doubles every 35 years with 2 percent annual inflation, the central bank said in 2006.
The benefit of a price-level target rests on distinctions that may be too subtle for people to appreciate, said Christopher Ragan, a former adviser to the central bank and finance department and a McGill University economics professor.
“Most of the economic benefits of price-level targeting rely on the public thoroughly understanding how it differs from inflation targeting,” Ragan said. “It’s legitimate to be skeptical about whether the public will really understand the implications.”