While BOC is sending the right signal, fiscal policy is adding to inflation pressure, Kevin Lynch says.
Canada's fiscal and monetary policy should be tightened as fast as rate cuts and extra deficit spending were introduced when Covid hit to give the public a clear message inflation will remain under control, a former top federal cabinet adviser told MNI.
The Bank of Canada and Prime Minister Justin Trudeau's government have been too slow pulling back stimulus after several quarters of evidence the economy was returning to normal and pushing full employment, said Kevin Lynch, whose public service career included leading the branch of government that organized cabinet meetings, deputy minister of finance and industry departments and Canada's top official at the IMF.
"The degree of monetary stimulus and the degree of fiscal stimulus stayed longer than it probably should have, and therefore you incented too much money chasing too few goods," he said in an interview Friday at the Canadian Economics Association conference.
"The same way you have to move very quickly to get support in, you also have to be pretty adept at calibrating when you bring it back out, so it’s symmetric,” he said. “The economy, as soon as we started to relax the shutdowns, it came back quite quickly because there weren’t underlying problems in the economy."
While the Bank's 125bps of rate hikes to 1.5% between March and June somewhat mirrors the 150bps of cuts made in March 2020 as Covid shut the economy, Governor Tiff Macklem has declined selling federal bonds acquired under QE in favor of waiting for maturing assets to roll off the books.
GETTING THROUGH THIS QUICKLY
Overall the Bank is sending the public the right message about bringing inflation back to the 2% target, Lynch said. Inflation hit 6.8% in April and is expected to touch 7% soon, the highest level since the early 1980s.
“That’s the right policy and signaling because what you don’t want is inflation expectations to get set in. That was our problem in the 70s, the 80s and 90s, when you assumed there was inflation there, then you behaved that way,” he said.
“If the Bank and policymakers can actually convince people that they will get inflation back down, and it doesn’t get into the systemic expectations, then I think there is a chance we can get through this quite quickly.”
Fiscal policy remains tilted toward active stimulus, with the last budget in April spending more than half the windfall from the economic rebound. The Liberals haven't aimed for a balanced budget since coming to power in 2015 and haven't fashioned any longer-term plan to pay back the record debt added to tackle the pandemic.
Part of the issue is that while interest rates can be moved at one of the eight announcement dates each year, governments have fewer chances to outline fiscal plans, Lynch said, though he suggested some restraint is needed.
“You now have an economy where we’re at pre-pandemic levels of GDP, we’re actually at higher than pre-pandemic levels of employment,” he said. “In that sort of world, close to a full employment world, deficits add to the demand pressures on the economy, and that’s just a reality.”
Still, conservative leadership candidate Pierre Poilievre's call to fire Governor Macklem over the inflation miss is wrong, Lynch said, adding independence is important and the central bank has served Canadians well for a long time.