Opinion: The need for monetary policy independence will be stronger than ever in the coming months


Customers shop at Ponesse Foods at Toronto’s St. Lawrence Market on January 19.Fred Lum/The Globe and Mail

Steve Ambler, professor of economics at the University of Quebec in Montreal, holds the David Dodge Chair in Monetary Policy at the CD Howe Institute, where Jeremy M. Kronick is Associate Director, Research and William Robson is Chief direction.

Times when inflation is low and few people pay attention to the central bank are happy times.

In Canada, these are not happy times. Inflation is high and the Bank of Canada is under surveillance. Discontent will grow as the bank raises its key interest rate to bring inflation back to its 2% target, as tighter monetary policy will pinch consumers and businesses before reducing inflation.

This poses risks – including that politics interferes with monetary policy. Since politicians don’t like monetary policy pinches, interference could lead to higher inflation for longer. Strange as it may seem when the Bank of Canada has already allowed inflation to overshoot, continuing to protect the institution’s independence is the most promising path to return to low inflation.

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Criticism of the bank’s policies over the past 18 or so months is fair. After all, the year-over-year increase in the consumer price index was 6.7% in March, more than double the top of the 1-3% range around the bank’s objective. This result is the result of the bank’s reaction to the pandemic, although well calibrated to the initial emergency, remaining too strong for too long.

The bank quickly lowered the overnight rate when the pandemic began and began buying financial assets, including longer-term Government of Canada bonds – the program known as quantitative easing ( QE) – to ensure that liquidity was cheap and readily available when the economy recovered. likely to block completely. Such measures prevented the damage that COVID-19 would inevitably cause to the economy from multiplying.

However, the Bank of Canada, like many other central banks, misjudged the extent to which further stimulus was needed once the worst of the crisis had passed.

They were inspired by the period following the financial crisis and recession of 2008-2009, when central banks kept their key interest rates extremely low for more than a year, and many pursued programs of quantitative easing to the point where their balance sheets were several times larger than before the crisis. Despite this monetary stimulus, inflation remained low.

A key difference this time around is that, in addition to continued monetary stimulus, governments across Canada continued to run huge consumption-driven deficits long after the crisis period ended. This has boosted demand in a world where supply cannot keep pace due to tight supply chains, Russia’s invasion of Ukraine and damage to production capacity by two years closing.

Staying too strong for too long was a mistake, especially as massive fiscal stimulus continued – but the Bank of Canada was not alone in doing so. The US Federal Reserve, Bank of England, European Central Bank and many others have done the same, and their currencies are also falling.

Before this pandemic episode, the Bank of Canada had an excellent record in controlling inflation. Between December 1995 and December 2019, inflation averaged 1.9% and was within the target range of 1-3% almost 80% of the time. This record reflects not only sound monetary policy, but also the advantages of the Bank of Canada’s independence from government: the ability to adjust its policy in response to inflation rather than to follow other imperatives, like keeping interest rates low ahead of the election or buying government debt when other lenders won’t.

The need for monetary policy independence will be stronger than ever in the months and years to come. To keep inflation under control, the bank recently raised the policy rate by 50 basis points – the first hike of more than 25 basis points in more than two decades. It also reverses QE by allowing bonds it holds to mature and not buying new ones, even as the federal government continues to issue new debt. Higher interest rates will pinch and put pressure on the federal budget. The bank must be free to continue to raise its policy rate and manage its balance sheet without political interference.

In the longer term, digital currencies of various types could become serious competitors to currencies issued by central banks, including the Bank of Canada. While there are potential benefits for these competitors, there are also dangers to the bank’s ability to conduct monetary policy. A central bank digital currency tied to the loonie is one way the bank can encourage Canadians to use their own dollar rather than, say, a cryptocurrency tied to a foreign currency.

But if threats to the bank’s independence harm confidence in the Canadian dollar, in its current or future digital form, the bank’s ability to provide a currency with predictable purchasing power could erode, which would further compromise the control of inflation.

The Bank of Canada has its work cut out for it. In the short term, it must bring inflation back to its target. In the longer term, it must maintain the attractiveness of the Canadian dollar relative to its existing and emerging rivals. Independence will help the bank provide Canadians with the reliable currency they want.

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