Finance Minister Jim Flaherty and Bank of Canada Governor Mark Carney are poised to formally acknowledge that a narrow focus on fighting inflation is no longer enough to provide stable growth in the Canadian economy.
The Harper government is due to renew the central bank’s marching orders by the end of the year, and all indications are that the inflation-targeting regime credited with keeping price gains fairly reliable for two decades will remain largely as is.
However, based on public comments by Mr. Carney in the past year, the new five-year mandate is likely to include a forceful assertion of what he calls “flexible inflation targeting,” or his right to respond to economic shocks or dangerous buildups of credit by taking longer than usual to bring inflation to the central bank’s 2-per-cent target.
The mandate is important because the financial crisis and its aftermath exposed the limits of monetary policy, spurring calls for central bankers to take on a more activist role in preventing financial meltdowns like the one caused by the U.S. subprime-mortgage collapse. There is no consensus on how or even whether to do this, in part because dangerous financial bubbles are hard to identify before they burst. But there is a growing sense that pure inflation-targeting is insufficient for the post-crisis economic realities.
Canada in 1991 was one of the early adopters of inflation-targeting, a system now used by most advanced-world central banks, which has made the rapid price gains of the 1970s and 80s a distant memory. Michael Wilson, the Mulroney-era finance minister who approved the bank’s first inflation-targeting regime, said in an interview that he counts it as “one of the real successes” from his time in office.
Still, since 2006, the bank has been exploring how it could be improved.
Given the volatility in markets and the shaky economic climate, big changes are very unlikely. Indeed, Prime Minister Stephen Harper told Bloomberg News last month that he does not anticipate “radical” or “significant” changes to the bank’s mandate, and Mr. Carney has said there is a “high bar” for tinkering with a well-functioning status quo.
But in recent speeches and interviews, Mr. Carney has emphasized that he retains considerable flexibility in how long he takes to meet his inflation target, depending on the circumstances.
“Our decisions are guided by considered analysis and informed judgment rather than mechanical rules,” Mr. Carney said in a Sept. 20 speech in Saint John. “Both the size and nature of the shocks that hit our economy can have a bearing on the appropriate targeting horizon.”
The central bank’s mandate already allows that in some situations, taking longer than the typical six to eight quarters to return inflation to 2 per cent “might be considered.”
The current grinding recovery, though, has required central bankers to think outside the box more than anyone could have envisioned five years ago. Like U.S. Federal Reserve Board chairman Ben Bernanke, and Mervyn King, Governor of the Bank of England, Mr. Carney has kept his benchmark interest rate on hold in the face of hotter-than-expected inflation, judging that securing the recovery is more important than being precisely on target.
On the flip side, Mr. Carney has said while the main “lines of defence” against financial imbalances should be prudent behaviour by banks and consumers, plus strong supervision and regulatory moves by government agencies that have the authority he lacks, there may be a “secondary role” for monetary policy. He has hinted he could lean against excess borrowing by raising interest rates or declining to cut them, even if it means inflation is lower than his target for longer.
The global re-thinking of post-crisis monetary policy comes at a sensitive moment in the relationship between the central bank and the government. While Mr. Carney has “operational” free reign to implement his mandate, he is not completely independent, and renewing the inflation target is a rare opportunity for Mr. Flaherty to weigh in.
Despite the fact that a chance to debate the Bank of Canada’s direction only comes up every five years, Parliament has no plans to hold hearings on the subject. The current chair of the standing committee on finance, Conservative MP James Rajotte, says his panel is simply too busy.
Mr. Carney is tentatively scheduled to appear before the committee on Nov. 1, the week after he releases a quarterly economic forecast, and legislators will be free to ask the Governor whatever they wish then, Mr. Rajotte said. However, when Mr. Carney appeared before the panel with Mr. Flaherty during an August emergency session to discuss the deteriorating global backdrop, none of the members asked how the mandate review was going or sought to provide input.
While the mandate renewal is usually non-controversial, there have been cases where a crucial disagreement on policy complicates things.
Most recently, when former Liberal finance minister Paul Martin learned in 1993 that then-governor John Crow wanted to push the inflation target lower than 2 per cent and possibly lower still, the two men realized their views were clearly at odds. Mr. Crow, of course, introduced the targeting regime now viewed as a mostly unqualified success, but before that his aggressive efforts to stem price gains were widely blamed for causing the 1990-91 recession.
His term was not extended when it ran out shortly after the Liberals took office.
“Reasonable people can have differences,” Mr. Martin said in an interview.