The Bank of Canada’s loose approach to meeting its 2-per-cent inflation target is helping it adapt to changing circumstances and may allow it to use interest-rate moves to counter credit imbalances that threaten the economy, Governor Mark Carney said.
But he also suggested the bar is still high for using monetary policy to deter households from gorging on debt.
In a speech Friday morning in New York, Mr. Carney vigorously defended the central bank’s “flexible” inflation-targeting regime, which has seen him keep interest rates at 1 per cent since September, 2010, the longest pause in several decades, even as gains in consumer prices have exceeded 2 per cent for much of that time.
The speech, to a conference on monetary policy, was the latest of many appearances in recent months in which Mr. Carney has said his mandate includes leeway to take longer than usual to return inflation to the target pace, if that’s what it takes to protect against economic or financial shocks.
“In a complex and continuously evolving world that no one can predict with certainty, policy-makers need a robust framework; one that remains appropriate no matter the circumstances,” Mr. Carney said in a text of his remarks. “Not only does a flexible (inflation targeting) framework enable the central bank to deal with shocks, it also provides the flexibility to address a buildup of financial vulnerabilities that a low-for-long environment can fuel.”
The Bank of Canada’s targeting regime, which in November was renewed for another five-year agreement with the federal government, formally acknowledged that in the wake of the global crisis, safeguarding financial stability is as crucial to economic health as achieving price stability. Mr. Carney repeated Friday that as long as consumers and businesses are confident that the central bank will generally try to keep inflation advancing at a 2-per cent annual pace over a reasonable timeframe, policy makers can sometimes tweak the rulebook. For instance, by leaving borrowing costs low for longer to try to kickstart a soft labour market, or by raising them sooner to keep an asset or credit bubble from forming.
“The way in which we achieve the goal can be adjusted, depending on the circumstances,” he said. “The exercise of flexibility cannot be arbitrary, and it requires a clear and transparent communications approach, which is important to both the accountability and effectiveness of monetary policy.”
Mr. Carney repeated his view that in exceptional cases, “when financial imbalances pose an economy-wide threat or where imbalances themselves are being encouraged by a low interest rate environment, monetary policy itself may be needed to support financial stability.”
However, even though the central bank’s concern about Canadians’ record levels of household debt has escalated in recent months, Mr. Carney said he still views prudent behaviour and regulatory moves by government agencies as the best ways to address the issue. In doing so, Mr. Carney suggested that while he and his policy team view household debt as the main risk to the domestic financial system and economy, he is not convinced that it is as much of a threat to the recovery as external headwinds like the European debt crisis.
“Monetary policy has a broad influence on financial markets and on the leverage of financial institutions that cannot be easily avoided,” he said. “This bluntness makes monetary policy an inappropriate tool to deal worth sector-specific imbalances but a valuable one to address imbalances that may have economy-wide implications.”
Also, Mr. Carney endorsed recent moves by the U.S. Federal Reserve to revolutionize that central bank’s efforts to communicate what it is trying to achieve with its policies, by stating definitively last month for the first time that it would aim to keep inflation at 2 per cent and revealing the interest-rate projections of all 17 officials that participate in policy discussions. (Those projections led the Fed to declare that it likely would keep its benchmark interest rate near zero until the end of 2014.)
The Fed’s inflation target will help it “boost the aggressiveness of its communications strategy,” Mr. Carney said, and “will enhance the stimulative effect of” its interest-rate pledge. The Canadian central banker -- who during the crisis took the extraordinary step of promising to leave rates on hold for a long stretch as long as inflation remained under control, his so-called “conditional commitment” -- hinted he might eventually consider publishing rate forecasts during normal times, too.
“The Fed’s experience with a published interest rate path in conventional times, when they return, is something we will watch with interest,” Mr. Carney said.