MNI INTERVIEW2: Ex-BOC Chief Says Neutral Rate Is Rising
Higher neutral rates will tempt indebted governments to pressure central banks, former BOC Governor Dodge says.
Neutral interest rates in Canada and the U.S. will climb at least a percentage point through this decade to a range of 3% to 4%, raising the risk that governments will pressure central banks to inflate away record debt burdens, former Bank of Canada Governor and top finance department official David Dodge told MNI.
Pressures on neutral rates include China's shift to saving less; climate change; ageing Baby Boomers drawing down retirement funds and driving up healthcare costs; and investment for digital transformation, said Dodge, now an adviser at the Bennett Jones law firm.
Higher neutral rates can flow through to longer-term bond yields and pressure governments struggling with fiscal discipline, Dodge said, and politicians haven't been candid about a period of cutting back consumption to make way for investment after the upheavals of the past few years. "It's a very tough period coming up for governments," and "you can't borrow your way through it," he said. (See: MNI INTERVIEW: Trudeau Must Fix Housing Without Fanning Prices)
Potential for knock-on changes at central banks are in play even in Canada, a pioneer of inflation targeting within the G7, amid voter anger over surging grocery bills and rental costs. The main opposition leader who's ahead in the polls has made firing Governor Tiff Macklem a signature promise, and a new bill in the unelected Senate proposes more political scrutiny of the Bank and a group of outside policymakers unseen since the Bank's founding in the Great Depression.
Finance Minister Chrystia Freeland and Prime Minister Justin Trudeau have also broken convention by welcoming the Bank's rate hold last month, and there's a global conversation about boosting inflation targets to 3%. Dodge suggests there are dangers in these kinds of actions. (See: MNI INTERVIEW:Trudeau Pushes BOC To High-For-Long Rate-Asselin)
CENTRAL BANK OVERRIDE
“There’s always a risk that governments will try to override central banks and say it’d be a lot easier if you only tried to hit three percent inflation as opposed to two,” he said.
“Just from a global systemic governance point of view, there’s every reason that the government or the king would debase the currency,” he said, adding that central banks won their independence when governments themselves realized "they didn’t want to be tempted all the time.”
While arguments for a higher inflation target aren't unreasonable, Dodge pointed to decades of evidence showing major social benefits from the stable inflation the current system has delivered. Canada's original debate on a 2% target focused around evidence that was likely a level sufficient to contain prices without being too disruptive for wage bargaining, and some argued back then even that target was lax.
Dodge's neutral rate estimate is higher than the Bank's view it lies between 2% and 3%, though current Governor Tiff Macklem has said interest rates are unlikely to return to the lows seen following the 2008 global financial crisis. Given the uncertainty Dodge said that for now policymakers need to focus on upside inflation risk.
“Confidence in hitting the target has eroded and so central banks naturally are going to have to err on the upside on whatever they think is the appropriate level of either tightness or accommodation.”