The Bank of Canada has failed, not just Macklem

The Bank of Canada’s misjudgment of the economy has resulted in serious overshooting of its inflation target of two per cent, plus or minus one per cent. Not only did overall inflation, as conservatively measured by the CPI, rise 6.8 per cent in April, but 70 per cent of its components were above the Bank’s upper limit of three per cent. Inflation is trending higher every month, as prices rose in March and April at a 10.2 per cent rate. May will be worse when Statcan finally incorporates used car prices in the CPI and gas prices continue above $2 a litre.

Headlines say inflation is the highest in three decades, but the 6.9 per cent rate in January 1991 was actually a one-month spike due to the introduction of the GST. In reality, inflation in Canada is undergoing its sharpest and most prolonged resurgence since 1983, almost 40 years ago.

Bank of Canada Governor Tiff Macklem lamely defends his institution, saying “we got more things right than we got wrong.” Nonsense. What the bank got wrong was the only thing that should matter to a central bank: controlling inflation.

Macklem should follow former Fed Chair William Martin in acknowledging he has made a mistake. When Martin retired in 1970 with inflation running at 4.7 per cent, he frankly admitted at his farewell luncheon: “I’ve failed.” Such candour and the promise to do whatever it takes to return inflation to its two per cent target as soon as possible would restore the bank’s credibility a lot faster than its own speculation, however transparent, about possible future interest rate moves. The bank’s target needs to be inflation, not interest rates.

Macklem is not alone in his reluctance to admit the Bank stimulated the economy too much and underestimated the risk of inflation. Stephen Poloz steadfastly maintains inflation is transitory, a misreading he made as governor that helped spark the inflation for which Macklem is being blamed. Poloz argues the slashing of interest rates and massive purchases of government bonds in 2020 were necessary to prevent the pandemic tailspin from becoming a 1930s-style depression. But that’s debatable. The economy did decline sharply and financial markets were precarious in March and April 2020 when governments shuttered large parts of the economy. But it is not obvious that after the initial shock of the pandemic’s onset the economy’s problems went much beyond lockdowns and social distancing, which were best addressed with targeted fiscal stimulus.

The economy and financial markets recovered quickly as lockdowns eased and most industries adapted to the pandemic with a creative combination of remote work and personal protective equipment. By summer 2020, it was clear the economic damage had been largely contained to industries that required face-to-face contact, comprising about one-quarter of the economy. Targeted support programs would have helped these industries survive until vaccines became widely available. Instead, governments continued with massive economywide fiscal and monetary stimulus — as if they were dealing with a deep-rooted crisis like that in 2008-09. The inevitable result of too much stimulus was rising inflation.

Not controlling inflation coming out of the pandemic is not the Bank of Canada’s only recent failure. Under Poloz, the Bank for years failed to engineer its hopedfor transition from debtfuelled household and government spending to more sustainable gains in exports and investment. But both exports and investment required the business community’s cooperation, and that was not forthcoming after the 2015 election of Justin Trudeau and his anti-growth agenda.

The Bank of Canada cannot be blamed for Trudeau’s poor economic policy, but it can be faulted for keeping interest rates low and encouraging a string of fiscal deficits in a forlorn attempt to goose growth. For years the Bank for International Settlements, the research clearing house for central banks, has warned governments that, at best, easy money policies would only buy them time to adopt policies that boost long-term potential by encouraging business investment, lowering barriers to inter-provincial trade, and cutting regulatory red tape. But rather than raise potential growth in these ways, governments relied on low interest rates to sustain growth for more than a decade.

Monetary policy should only be used to stabilize the economy against shortterm unexpected shocks, not fuel excessive demand for years on end. Governor Poloz should have been more forceful in pushing a growth agenda and less cooperative in providing monetary stimulus. Increasing potential growth over the past decade would have helped limit today’s supply constraints. Instead, the only choice now is to lower demand to meet constrained supply.

Central banks should not be let off easily for their mistakes leading up to and during the pandemic. The Bank of Canada calculates that inflation of even five per cent costs every Canadian $2,000 a year in lower real income. In the short term, inflation risks both recession and financial market turmoil as interest rates are raised to fight it, while in the longer term it depresses an economy’s potential by increasing uncertainty.

Central bank independence means Canadians forego democratic control of the Bank of Canada in return for its unwavering commitment to low inflation and fiscal stability. When these goals are not achieved it is only reasonable to demand some degree of accountability. The surge of inflation reflects an institution’s failures over a prolonged period, not an isolated mistake by one individual.

THE INEVITABLE RESULT OF TOO MUCH STIMULUS WAS RISING INFLATION.