MNI INTERVIEW: BOC Walks Fine Line On Big Rate Hikes-Ex Deputy

The Bank of Canada must strike a balance between taming inflation and derailing the expansion as it tightens monetary policy, though the economy's momentum provides a path away from 1970s-style stagflation, former Deputy Governor John Murray told MNI.

Keeping price expectations in check is key because once these shift up they are much harder to contain, said Murray. “That's why the Bank of Canada and the Fed are prepared now to take more aggressive action like the 50-basis point move as evidence of their commitment, their determination to bring it down,” he said. “You're walking a fine line because you don't want to appear panicked either, because that could un-anchor expectations and get households and businesses concerned.”

Canada benefits from a three-decade track record of keeping inflation near 2%, but overdoing rate increases could risk a recession or destabilize financial markets, said Murray, a deputy governor from 2008-2014 who joined the Bank in 1980.

“We may still get out of this and in better shape than dealing with the sort of Volcker-type medicine that was necessary to confront the problems of the 1970s," he said in reference to the former Federal Reserve chief known for quashing inflation with high rates. "We're looking at a situation right now where the Canadian economy and certainly the U.S. are at full employment or above.”

NO-WIN SITUATION

Normalizing rates is tricky because the economy is moving past full output and the impact of the Ukraine war, Covid and supply disruptions remains very uncertain, he said. Since central banks can't show they are removing stimulus until they bring rates to neutral, “it’s still important to have a sense of where neutral is,” even if that's harder to identify, Murray said. The Bank recently raised its neutral estimate 25bps to 2.5%, giving more room to hike from today's 1% policy benchmark.

Governor Tiff Macklem told lawmakers Monday he will look at a second 50bp rate hike for the next decision June 1 and said any bigger move than that would be unusual. He has a second round of testimony Wednesday night.

Today's situation has no single precedent but is a mix of elements of the 1960s, 1970s or from nations hit by a natural disaster, Murray told MNI. Canada may also be more sensitive now to higher interest rates given elevated government and consumer debt.

“Once we start confronting the high inflation and interest rates continue to rise, and I think they will rise faster than people anticipate, or further than people anticipate, you'll hear a lot of complaining about that too. So it's kind of a no-win situation,” Murray said.

EXTRAORDINARY CIRCUMSTANCES

Repeating the 1970s remains unlikely because expectations are better anchored and policy makers less willing to trade between inflation and jobs, Murray said. Inflation is now at a three-decade high of 6.7%. It averaged 7.4% in the 1970s and 2.2% in the 1990s following Canada's adoption of inflation targets in 1991.

Relieving pressure from higher global oil prices is tougher with tight economies creating broader inflation, meaning less room to create slack elsewhere, Murray said. “It makes it more difficult because of the inherent stickiness and importance of some prices, but not impossible,” he said.

While global policymakers may have erred with too much stimulus during the pandemic, Murray said, it was more dangerous to allow deflation or mass unemployment given fiscal and monetary space was already limited.

"I'm sympathetic to the extraordinary circumstances they faced," he said.

With the lag from interest-rate changes to the economy, it would have taken “amazing foresight” last year to predict the rebound let alone the Ukraine war, he said, and leaders couldn't have sold the need for austerity. “They wouldn't let you get away with that. Even if you were right you would have a lot of explaining to do.”