My first entry was supposed to be some sort of greeting, or maybe something about the blog's name. But instead I am going to briefly address an issue that has been nagging at me for a long time: the notion that the Bank of Canada's role is limited to controlling inflation. I was reminded about this earlier this week amidst the usual buzz that occurs before the central bank announces whether or not it is going to change its target for the overnight rate. My own view is that there is something missing when reporters, commentators and experts—including the Bank's governor himself—speak as though the Bank's purpose is solely to keep a lid on consumer prices, period. What about unemployment? Or the state of Canada's manufacturing industry
Well, it turns out that there is indeed something missing from this picture. Normally, to find out more about a government agency's role or mandate, you turn to the list of legislative responsibilities contained in the agency’s enabling statute—in this case the Bank of Canada Act. In the legislation, it so happens that the opening words—the preamble—make it clear that the Bank’s legislated mandate is
Well, apparently, there’s more to it than legislation. The Bank also takes its lead from an inconspicuous, little-known agreement between the Government of Canada and the Bank of Canada that essentially directs the central bank to prioritize inflation-control over other alternative targets. The agreement has been in effect since 1991 and is still at the heart of the Bank’s inflation-targeting framework. Under this regime, the central bank adjusts its interest rate target based on a deviation of actual inflation rates from targets as well as on the output gap (differential between potential output and actual output). In a way, the belief underpinning this strategy is similar to the old Philips curve notion according to which inflation is said to rise if the unemployment rate gets too low. Although it may sound like a decent trade-off, I still have a hunch that under this regime the Bank shows far more concern with controlling inflation rather than to addressing unemployment.
So what is the problem, you might ask? Well, I dunno, how about for starters the fact that there is little evidence that this type of rigid inflation-targeting is effective policy. For instance, economist Pierre Fortin has been saying for years that the Bank has tended to underestimate the size of the output gap, and thus overestimate the risk of inflation. Moreover, it could be argued that the Bank somewhat violated the terms of its agreement with the Government during the 1990s given that inflation was kept below its stated target of two percent during most of that period.
But more importantly, let us keep in mind what this really means. Basically, it signifies that during the last twenty years an agreement reached between a few cabinet ministers and a handful of government officials has been trumping legislation enacted by Parliament. Imagine if the same thing happened in the US? Members of Congress would have a field day interrogating the Fed chairman about his involvement in such an agreement. Of course, such a thing would be most unlikely. But if it occured, it would make the proceedings of the US Senate Committee on Finance well worth watching.
Well, it turns out that there is indeed something missing from this picture. Normally, to find out more about a government agency's role or mandate, you turn to the list of legislative responsibilities contained in the agency’s enabling statute—in this case the Bank of Canada Act. In the legislation, it so happens that the opening words—the preamble—make it clear that the Bank’s legislated mandate is
to regulate credit and currency and control and protect the external value of the national monetary unit, but to also to mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada. (my emphasis)Now, I think it is safe to say that, in the words of central bankers, slaying inflation is not the only game in town. So why is it that the Bank’s press releases and Mark Carney always focus on the devil of inflation rather than the equally horrible monster that is unemployment, even while the spectre of inflation is nowhere to be seen lately? Sure, the Bank's officials have had talking points handed to them recently about Canada’s low household saving rate and rising level of debt to disposable income. But how genuine are these concerns given that both these trends have existed for years?
Well, apparently, there’s more to it than legislation. The Bank also takes its lead from an inconspicuous, little-known agreement between the Government of Canada and the Bank of Canada that essentially directs the central bank to prioritize inflation-control over other alternative targets. The agreement has been in effect since 1991 and is still at the heart of the Bank’s inflation-targeting framework. Under this regime, the central bank adjusts its interest rate target based on a deviation of actual inflation rates from targets as well as on the output gap (differential between potential output and actual output). In a way, the belief underpinning this strategy is similar to the old Philips curve notion according to which inflation is said to rise if the unemployment rate gets too low. Although it may sound like a decent trade-off, I still have a hunch that under this regime the Bank shows far more concern with controlling inflation rather than to addressing unemployment.
So what is the problem, you might ask? Well, I dunno, how about for starters the fact that there is little evidence that this type of rigid inflation-targeting is effective policy. For instance, economist Pierre Fortin has been saying for years that the Bank has tended to underestimate the size of the output gap, and thus overestimate the risk of inflation. Moreover, it could be argued that the Bank somewhat violated the terms of its agreement with the Government during the 1990s given that inflation was kept below its stated target of two percent during most of that period.
But more importantly, let us keep in mind what this really means. Basically, it signifies that during the last twenty years an agreement reached between a few cabinet ministers and a handful of government officials has been trumping legislation enacted by Parliament. Imagine if the same thing happened in the US? Members of Congress would have a field day interrogating the Fed chairman about his involvement in such an agreement. Of course, such a thing would be most unlikely. But if it occured, it would make the proceedings of the US Senate Committee on Finance well worth watching.
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