Every five years, the Bank of Canada renews its agreement on the country’s inflation-control target. The BoC is due to announce its new framework in 2021, and this time around, it has asked Canadians for their opinions.
Jocelyn Paquet, economist at National Bank of Canada in Montreal, said the BoC confirms its mandate every five years — or proposes a new one — “to seek legitimacy.” This legitimacy will be stronger if public input informs the bank’s decisions.
The central bank conducted a survey that ended Oct. 1 to seek the public’s opinions on five main policy options: the current policy of inflation targeting; targeting the level of aggregate prices; targeting average inflation; targeting nominal GDP growth; and an employment-inflation dual mandate.
More than 8,000 people responded to the survey, according to the BoC.
Our sister publication, Finance et Investissement, asked experts to weigh in on the options.
Most signs point to the central bank renewing its current inflation-targeting policy.
Paquet suggested the main reason the BoC is reviewing its monetary policy is because the U.S. Federal Reserve recently moved away from its dual mandate of full employment and targeting exactly 2% inflation.
In August, Fed chair Jerome Powell announced the U.S. would adopt average inflation targeting, thereby allowing the rate to rise above 2% if it had previously been lower to support the labour market and the economy as a whole.
In recent years, U.S. inflation has generally run below the target.
Benjamin Reitzes, director of Canadian rates and macro strategist at Bank of Montreal in Toronto, says the BoC’s current inflation-targeting policy is more flexible than the Fed’s. That’s because Canada is not targeting inflation at 2% exactly, but rather a range of 1% to 3%.
“In fact, since the BoC’s last policy renewal in 2016, the bank has managed to achieve its mandate over the entire cycle,” Reitzes said.
A clear mandate
The BoC has been testing its five policy options to determine which are most effective in generating optimal economic growth, inflation and employment.
It held a workshop on Aug. 26 to share the preliminary results: of the five options, the three that performed best were the current policy, average inflation targeting and a dual mandate.
The bank will not necessarily choose the best-performing option, Paquet said, noting that it has other considerations: “It is important that citizens understand what its mandate is,” she said.
She believes the current framework will be maintained. “It’s a relatively easy-to-understand framework. That’s less evident when targeting average inflation. In the United States, people are already asking questions: ‘You say you are ready to beat inflation, but how far are you prepared to go and how long will you exceed 2%?’” Paquet said.
Reitzes pointed out that it’s difficult to explain price-level targeting and the targeting of nominal GDP growth, adding that the BoC will probably reject these two options.
But Reitzes suggested the bank could introduce some sort of dual mandate, adding that the BoC already aims for maximum employment levels in its current mandate.
Raymond Kerzérho, director of research at PWL Capital in Montreal, favours a dual mandate.
“A 50/50 mandate does not preclude a stronger short-term prioritization of one of the two parameters, depending on the context,” Kerzérho said.
Reitzes noted, however, that employment and inflation are linked. “If you get a super strong employment rate and wages go up a lot, it drives inflation and vice versa,” he said. “At the end of the day, it really comes down to inflation. This is why the status quo seems to make more sense, with perhaps a few [innovative adjustments],” he said.
Winners and losers
Kerzérho said it’s difficult to determine who benefits most from inflation targeting. Inflation is currently falling, “and there’s a risk of negative inflation, which is not good for pretty much anyone except maybe a few speculators.”
According to Kerzérho, inflation is set to fall below 1%, “and the bank will have a lot of difficulty attaining 2%. I find it hard to understand that many experts still predict 2% in the long term,” he said.
Reitzes said inflation targeting tends to prevent policy-makers from managing other economic challenges.
“You don’t necessarily focus on the stability of financial and capital markets,” he said, referring to 2000-01 and 2006 in the U.S., when the Fed did nothing to cool markets because there was no inflation.
Nonetheless, Reitzes said, the BoC’s methods are less problematic: by having a more flexible target inflation range, the BoC can also account for market stability.
If the central bank adopted average inflation targeting, Paquet said, it could potentially keep interest rates lower for longer, benefiting borrowers. Under an inflation-targeting policy, the BoC could become more restrictive more quickly. Savers rather than borrowers would then benefit, she said.
However, National Bank analysts do not expect rates to rise significantly in the next 18 to 24 months.
This article originally appeared in the Mid-October issue of Finance et Investissement.