Parliament Hill in Ottawa

If Canada’s monetary policy is not broke, don’t fix it

By: Pedro Antunes, Sohaib Shahid

This op-ed was originally published by The Globe and Mail on November 16, 2021.

It’s human nature to want to improve things. But sometimes, in trying to make things better, we can end up making them worse. So knowing when to act, and when not to, is often a sign of wisdom. In other words, if it ain’t broke, don’t fix it. And that is what’s needed as the Bank of Canada renews its mandate with the federal government for the next five years.

Since 1991, the central bank’s mandate to keep inflation within the 1-to-3-per-cent range—ideally, 2 per cent—has served Canadians well. Inflation has averaged 1.8 per cent annually for the past three decades. Stable, predictable inflation has made it easier for households to budget their spending and savings and for businesses to adjust their operations and plan their investments.

The Bank of Canada is currently exploring alternative mandates. These include a dual objective of targeting inflation and full employment—such that the bank would allow for higher inflation if the unemployment rate were still high. Other alternatives include average inflation targeting (AIT), in which the central bank could aim for a period in which inflation is above its target to make up for a period in which it is below its target.

But the time isn’t right for a change to the current mandate. Changing it now may fuel concerns that the bank has lost its grip on inflation. This will especially be true if it comes with confusing messages about what to expect in terms of inflation in the coming quarters, which risk making the bank less credible in the eyes of Canadians.

Keeping inflation in check is as much about central bank credibility as it is about changing short-term interest rates or purchasing bonds (quantitative easing) to lower long-term rates. Take “forward guidance,” for instance, a central bank term that suggests it can affect consumer and investor behaviour by providing information about future monetary policy. The Bank of Canada saying it will not raise interest rates until “economic slack is absorbed” is an example of this.

For forward guidance to work, a central bank must earn the trust of its country’s citizens. And since the Bank of Canada has been delivering on its mandate for three decades, Canadians do indeed trust it. But it takes years to build trust—and just seconds to destroy it.

Recent inflation data have run well above the bank’s forecasts. The surge in prices is owing to a boost in domestic and global demand for goods and services, which has outpaced supply. Though the bank is forecasting inflation to be 3.4 per cent this year and next, it insists it is “transitory.” But Canadians are concerned. The Conference Board of Canada’s latest index of consumer confidence suggests that more than 25 per cent of Canadians expect inflation to be more than 5 per cent in five years.

Changing to a dual mandate could signal that the bank will allow for higher inflation if the unemployment rate remains high. But Canadians may also interpret that as inflation getting out of hand.

Besides, monetary policy is a blunt tool to target the labour market, let alone particular segments. And measuring “full employment” is notoriously tricky, especially when major structural shifts are occurring in the labour market. What’s more, adding another target to the bank’s mandate without expanding its toolkit would make it more challenging to communicate the dual mandate to Canadians and clarify how important each target is.

Changing the mandate to AIT could also be viewed as an excuse for the bank’s inability to control the current bout of inflation. Communicating AIT to the public may be problematic under other scenarios, too. Imagine the Bank of Canada signalling to tighten monetary policy to make up for previously high inflation that has since returned to target or moved below!

Under a dual mandate or AIT, Canadians are also likely to experience higher inflation than under the status quo. And since rising prices tend to disproportionately hit low-income Canadians, they will exacerbate the inequalities in our society. So, if the bank wants equitable growth, sticking with the current mandate is the best option.

The current mandate offers enough flexibility to consider factors such as employment when making interest rate decisions. It has also weathered multiple economic storms over the years, including the pandemic, so there seems to be little reason to change course.

The Bank of Canada’s existing mandate has served us well and is well understood, which may be why most Canadians are against changing it. A change would only be warranted if the alternatives were better. They are not.