MNI INTERVIEW: BOC To Steer Away From Average-Inflation Target

The Bank of Canada is likely to refrain from following the U.S. into average-inflation targeting, which could lead to price rises getting out of control, former research fellow Randall Morck told MNI.

"The way the Bank of Canada has been doing it makes sense going forward," said Morck, who won a multi-year research fellowship from the BOC when Mark Carney was governor. Asked whether the BOC would imitate the Federal Reserve which recently moved to average inflation targeting, he replied: "I don't think so."

BOC Governor Tiff Macklem must seek government renewal of its five-year inflation mandate in 2021, though reviews since the 1990s when Canada was the first G7 nation to adopt a target have stuck with a 2% goal. Other ex-officials have told MNI the current system should be renewed, rather than switched to targets such as price levels, GDP or a higher inflation rate.

"Average inflation targeting gives the Bank much more leeway to allow periods of high inflation," Morck, a University of Alberta professor, said in an interview last week, pointing to double-digit inflation in the 1970s which he said suppressed investment. "It seems to me to be creating scope for instability."

INFLATING AWAY DEBT

Higher inflation would also erode returns of government bondholders, as occurred after World War II.

"One way that you can pay off huge government debts is to suddenly inflate them away," Morck noted, as Canada's fiscal deficit approaches 20% of GDP this year.

Finance Minister Chrystia Freeland is right, though, to emphasize fiscal policy in the pandemic, he said, adding that the regular path transmitting lower interest rates to corporate borrowing and job creation has been broken.

"Right now, nobody is doing industrial expansion except Amazon and a few companies like that. You aren't going to get conventional channels of monetary policy working.

"Monetary policy then becomes something that just tries to keep government borrowing costs down," he said.

Canada faces a wave of consumer and business bankruptcies that could swamp courts and the banking system, and government spending "will make restarting things once there is a vaccine easier," he said.

FISCAL TARGET LACKING

Business leaders have told MNI that Freeland's lack of commitment to restoring a fiscal target such as debt as a share of GDP is feeding uncertainty and raises the prospect of unsustainable long-term spending. Freeland said last week the government has a duty to spend to pull the economy out of the pandemic, and that the BOC is running out of firepower.

With interest rates pledged to remain near zero into 2023 and bond purchases of at least CAD4 billion a week, the BOC must not only push inflation back up to target but also avoid also a market tantrum as it unwinds QE. Last month it slowed purchases from CAD5 billion a week.

"I'm sure they are thinking about these things, the Bank of Canada Governor is a very smart guy and I'm sure that these are things he's very worried about," Morck said.