MNI INTERVIEW: BOC Must Reach Neutral Rate Fast- Fmr Gov Dodge

The Bank of Canada and Federal Reserve need to lift interest rates to neutral in a hurry as rapid inflation puts public confidence at risk, former BOC Governor David Dodge told MNI.

Moving faster now will help avoid more severe overshooting in 2023 and 2024, said Dodge, who also cited danger from a broadening of wage demands. Major economies face supply constraints that will create inflation friction through the rest of this decade, he said.

“Central banks are behind the curve and they do need to move up quickly to something like neutral, we have historically thought that was around two and a quarter, two and a half, something like that in North America,” Dodge said. “The world is losing confidence in the ability of the Federal Reserve, but I would say of central banks more generally, to actually manage the situation.”

“You’ve got to get up there pretty quickly in order to stop any extrapolative expectations from beginning to form, absolutely, and to prevent having to go even further in ‘23, ‘24,” he said. The BOC on March 2 raised its overnight rate to 0.5% from a record low 0.25% to start on a "path" of tightening, and some economists see a half-point hike at the Apr. 13 decision and a shift to quantitative tightening.

The BOC should take a less aggressive approach paring down its balance sheet, Dodge said, in part to avoid a big swing in long-term lending rates that would further discourage lackluster business investment. “I’m not sure that I would be moving too expeditiously on the quantitative tightening side, as opposed to getting that overnight rate up,” he said.

TIGHT SUPPLY THROUGH 2030

Supply chains will remain under pressure through the rest of this decade with labor supply limited by population aging, geopolitical concerns over far-flung production networks and the cost of climate change, Dodge said.

“The supply issue is going to really dominate as we go forward to 2030,” he said. “We clearly had a shock that makes the globalization of production in a few localities much more risky and so we’re going to lose efficiency as we try to deal with that.”

Keeping pay rises for long-term employees near 2% in a tight labor market will also be impossible for the BOC if new hires keep getting several times that, Dodge said, a situation he likened to the 1970s when he served on a federal inflation control board.

“That supply issue isn’t going to right itself as it did in the 1970s with the whole surge of Baby Boomers who started to enter the labor force in the mid-1960s," said Dodge, who led the BOC from 2001 to 2008 and is now s a senior advisor at the Bennett Jones law firm. Governments also risk preventing market adjustments needed to cool inflation by doling out cash to consumers angry about high prices, Dodge said, speaking just before the finance minister announced the next budget will be delivered on Apr. 7.

HOT HOUSING, COOL LOONIE

One of the biggest areas of policy concern in Canada is around surging home prices, and Dodge said no one can be surprised at gains in major cities when government policy relies on immigration for economic growth and settles most new arrivals in metropolitan areas.

“Our governments will be very tempted, as will governments around the world, to try to cushion the impact of the rising prices," and the focus should be on boosting investment rather than new spending programs, he said.

Canada's dollar is failing to benefit from the energy boom the way it did in the last cycle because global investment in the country's heavy crude or natural gas exports is deterred by tougher regulation, he said. “There is very little confidence capital investment to raise our output over time will actually pay off,” he said.