The Bank of Canada, at the behest of the Federal Government of the time, adopted its inflation targeting strategy as long ago as 1991. Since that time, monetary policy has aimed to keep inflation (measured by consumer prices) close to 2 percent, within a range of 1-3 percent as conditions warrant. The advantage of this approach, now almost universal among major central banks, is that it provides clear guidance for markets and the general public about how the Bank will react as the inflation picture unfolds. The principal disadvantage is that it results in reduced emphasis on other important economic policy goals, such as the desirability of ensuring full employment.
The Bank and the Federal Government renew this arrangement every five years, which means that a review is coming in 2021. The Bank has been working hard at examining possible alternatives to the existing approach, and this week Senior Deputy Governor Carolyn Wilkins was the keynote speaker (virtually, of course) at a workshop at which the Bank revealed some of its current thinking. With new Governor Tiff Macklem now in place and the COVID pandemic complicating the Bank's task, it seems clear that significant changes may be coming next year.
It so happens that Gov. Macklem was also speaking this week, addressing (virtually) the Kansas City Fed's annual Jackson Hole gabfest. Clues about the Bank's thinking can perhaps be found in his comment that "The imperative is to step boldly beyond market transparency and engage with the public to explain how our actions serve our economy-wide objectives. This means listening to more people, understanding their perceptions — accurate or not — factoring in broader public views into our policy decisions and communicating with people on their terms, not ours."
If the Bank's objectives include transparency and simplicity, it has not always helped itself in the way it has implemented its strategy in the past. A few years ago it unveiled three arcane measures of core CPI that were supposed to be more reliable than the widely-followed headline CPI number in determining underlying price trends. Since they were introduced, these three series have rarely deviated by more than one or two tenths of a percentage point from the headline number. It would be little surprise if they were quietly dropped in the coming months.
The coronavirus pandemic has made the Bank's job difficult in many ways, even raising doubts about whether policymakers have the tools at their disposal to combat the economic impact of the virus, given that interest rates have been so low for so long. The pandemic is also complicating the coming decision about the future policy framework, mainly because it is reducing the faith that the public at large has in the published inflation numbers, as this article from the Financial Post explains very well.
Ms Wilkins addressed this at some length in her keynote address: "Last year during our consultations, we heard loud and clear that the measure of inflation needed to be considered. Many people feel that inflation is higher than reported. That’s why we started working with Statistics Canada last year to look for ways to improve the CPI....This work continues now at an accelerated pace, because COVID-19 has only exacerbated this perception of higher inflation. Prices that are falling, like those around travel, are not relevant to most people; but the prices that are rising, like the cost of food, are those we encounter every week. The price of meat has risen by more than 4 percent since February—before the pandemic hit Canada. That doesn’t feel like low inflation to me or to many families, yet measured inflation is close to zero when you consider the full basket of goods and services....It’s critical that we measure inflation as accurately as possible so Canadians have confidence in our target; and we must address public perceptions in our analysis and communications."
Against this background, the Bank is staging, to quote Ms Wilkins again, "a horse race among alternative frameworks for monetary policy. These include average inflation targeting, price-level targeting, an employment-inflation dual mandate and nominal GDP growth and level targeting. Another possibility is to raise the inflation target."
For those of us old enough to remember the bad old says of rampant inflation in the 1970s and 1980s, that last little sentence causes chills down the spine. It's surely not there by accident and it is no surprise that higher inflation is the theme picked up in the Financial Post article linked above. Governor Macklem's desire for simplicity surely rules out nominal GDP targeting, and a dual employment-inflation mandate would instantly become a political football. That doesn't leave much on the table.
Given the lengthy recovery that is in prospect in the wake of the pandemic, even getting inflation back up to the existing target withing five years might seem like a remote possibility. Setting a goal of lifting inflation to a higher level than that, and keeping it there, looks like an unnecessary risk for the Bank to contemplate.
The Federal Reserve has also been tinkering with its inflation targetry this week; more on this in a separate post.
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