MNI: BOC Must Cool Inflation Before Boosting Jobs-Ex Advisers

The Bank of Canada faces a protracted fight to slow inflation to the 2% midpoint of its target range before policymakers will be able to turn their attention to a new duty to seek full employment when their primary mandate to control prices permits them to do so, former advisers told MNI.

A revised mandate announced last week appears to clarify a longstanding informal practice, according to David Laidler and Angelo Melino, who said it will have little practical effect at a time when inflation has climbed to almost 5% and supply chains are seen remaining fragile well into next year.

“This is all irrelevant over the next two or three years, because I don’t see inflation getting back to 2% next year," said Laidler, a retired Western University professor. "The only way you’ll get it back to 2% next year is by some pretty crunchy interest-rate hikes, and I don’t think they are going to do that.”

After misreading the persistent nature of price gains triggered by the pandemic, the BOC wouldn't be wrong to hike in January, Laidler said. That would come before Governor Tiff Macklem's guidance that conditions for a rate rise won't be in place until at least April.

NEW MANDATE “CLUTTERED”

The new mandate seems “cluttered” compared to the prior focus on prices, Laidler said, adding that he was also uncomfortable with a reference in the joint announcement by the government and the BOC to flexibility over the 1%-3% inflation target range.

But Bill Robson, who chairs the CD Howe think-tank’s shadow monetary council, said it was not obvious the new mandate would lead to looser policy. It was a "relief" to see the core mission stick to controling inflation, which is likely to remain the priority for some time.

“We’ve had a recovery in employment that's been far more than the recovery of GDP, and if you elevate labor market indicators relative to the other things that we've been watching, then maybe it would even justify tightening earlier, and more,” he said.

TOLERATING SOME OVERSHOOT

The revised mandate also noted the need to tolerate some inflation overshooting when rates rise from near zero, something ex-advisers said will have a modest influence over decisions through the next five years.

“If you think you're going to be at the zero lower bound and have a hard time getting inflation back to target during those episodes, you're going to have to overshoot the target when you come out of the recession," said Melino, a University of Toronto economist who advised the BOC around the global financial crisis. "Otherwise, inflation on average is going to be below 2%, and that will lead into lower expectations at some point.”

There were already hints of a tolerance of inflation topping 2% in recent years, Melino said, pointing to the Bank's quarterly economic forecasts. Traditionally those projections were thought to require a finding that CPI would return to 2% at the end of a two-year projection horizon.

DON'T MESS IT UP

The mandate changes appear to incorporate lessons from the ECB and Fed since the global financial crisis, the ex-advisers told MNI.

“The lesson of the U.S. was that they waited much longer and they got the unemployment rate much lower than anybody thought they could. And so I guess that's something that the Bank of Canada picked up on and wondered, maybe we could we get below 6% unemployment,” Melino said.

While the ex-advisers acknowledged the need for democratic oversight of monetary policy, there was also nervousness about political interference in this round.

“This has proven to be as durable a monetary regime almost as you can think of," Robson said. "You're not doing anybody a disservice to say look, this is the best thing we've tried, and so why would you mess with it?”