Policy experts argue central bank missed cues from business pulse surveys, record-high readings, and other rate-setting bodies
Last week, the Bank of Canada left its overnight rate target at 25 basis points, surprising markets that had already priced in a rate hike. And in the eyes of two policy experts at the C.D. Howe Institute, the central bank’s decision represents a missed opportunity.
Steve Ambler, the David Dodge Chair in Monetary Policy and Jeremy M. Kronick, who serves as Associate Director, Research expressed their shared view in a recent open letter.
Markets had assumed the bank would raise its target interest rate because of steady increases in inflation and inflation expectations, the two said. In December, headline inflation jumped to 4.8%, all of the bank's core inflation measures increased – with two of the three at or above 3% – and its December Business Outlook Survey found two-thirds of businesses expect inflation to stay over 3% for the next 12 months.
As inflation has creeped upward, the Bank's belief that recent high inflation readings were just transitory has changed. Ambler and Kronick maintained that sustained government expenditure was warranted in the early days of the epidemic, but less so now. That policy stance, they suggested, is what’s behind current upward pressure on pricing as aggregate spending surpasses the present production capacity.
In their memo, the two authors also noted similar mistakes have been made in other countries, resulting in the same inflationary response. In December, Australia had 3.5% inflation, the Eurozone had 5%, the United Kingdom had 5.4%, and the United States reported a stunning 7%. In each case, the headline inflation rate increased from November.
“Yes, inflation is a worldwide phenomenon, but mainly because almost all countries are following the same inflationary policies,” the two authors said. “With prices continuing their rise, however, the world’s central banks have become significantly more hawkish.”
They cited the Bank of England’s decision to raise its policy rate by 25 basis points in December, the first time it did so since the pandemic began. The U.S. Federal Reserve has announced that it will raise its policy rate in March, and will begin to reduce its balance sheet at that time as well.
Unhelpful changes in global demographics may also result in sustained price increases at home, Ambler and Kronick said. They referred to the 2020 book The Great Demographic Reversal, where the authors Charles Goodhart and Manoj Pradhan explained how temporary demographic factors, notably a labour glut borne out of the integration of China and Eastern Europe into the world economy, have biased world inflation downward in recent years.
But as the world’s population ages and the working-age population grows more slowly, production costs are on the rise, compounding upward pressure from huge monetary and fiscal pandemic responses around the world. With higher global inflation impacting Canada’s open economy, the BoC will find it harder to push down Canadian prices.
“This is one of the many problems with an inflation fever; if it takes hold, it is hard to break,” Ambler and Kronick said. “Yes, interest rate medicine can be hard to swallow, as the Bank of Canada showed last week, but it does not go down any more easily if you put it off.
