Tiff sets out his stall

New Bank of Canada Governor Tiff Macklem made his first major policy speech on Monday -- remotely, of course -- to every Canadian club and cercle canadien across the country. The speech was titled "Monetary policy in the context of COVID-19".  Macklem addressed the key issues of the day by reference to the Bank's long-established 2 percent inflation target,  a clear sign that he intends to make no major changes in policy, at least for the time being.

The economic background against which the Bank must now make its policy decisions is well known.  The economy has suffered simultaneous supply and demand shocks.  Supply chain disruptions, the closure of non-essential businesses and the imposition of physical distancing led to "a massive decline in supply".  At the same time,  the rapid surge in unemployment led to "a very large drop in spending power across the economy", although Macklem notes that government measures to support labour incomes during the pandemic have laid the foundations for recovery.

The shape of the recovery in supply and demand will be the key determinant of the Bank's policy actions going forward. It appears to consider that the most likely scenario is one in which "supply is restored more quickly than demand, this could lead to a large gap between the two, putting a lot of downward pressure on inflation." This implies that monetary policy will have to remain highly accommodative for the foreseeable future, since as Macklem notes, "Our main concern is to avoid a persistent drop in inflation by helping Canadians get back to work."

Macklem's remarks did not disclose the reasoning or research behind the Bank's belief that supply will rebound faster than demand. That analysis will no doubt come when the Bank releases its updated Monetary Policy Report in July.  It is certainly possible to argue the opposite case.  The support that the Government has provided to households is likely to mean that in a national accounts context,  the hit to household incomes from the pandemic will be surprisingly small.

By contrast, many sectors of the economy will take a long time to return to anything like their previous normality, if indeed they ever do.  Many businesses that are coming back to life are facing considerably higher costs in order to keep everyone safe.  All those masks, plexiglass screens and sanitizers don't come free, and operating at less than full capacity makes it harder to cover fixed costs. Many businesses will be looking for ways to pass on those higher costs to their customers, which they may well be able to do if demand proves resilient. 

The Bank currently expects economic growth to resume in the third quarter.  This certainly looks to be true in the aggregate, but there is plenty of evidence that after precipitous falls in March and April, output began to revive in May, which would mean that the COVID recession will go down as both the deepest and the shortest in history. The Bank expects the recovery to be "prolonged and bumpy", with setbacks along the way. Macklem ended his remarks by describing the trusty inflation target as "our beacon that is guiding our actions". Evidently, the Bank thinks there is quite enough uncertainty in the world right now, without policymakers adding to it.