Bank of Canada Governor Mark Carney is in the op-ed section of the Financial Times Friday, boasting that his monetary policy framework is better than yours.
“In an unpredictable world, policy makers need a robust framework, one that remains appropriate no matter the circumstances,” Mr. Carney writes. “Flexible inflation targeting is that framework, a policy for all seasons.”
Comments of that kind make it sound like the debate within the Bank of Canada over the optimal policy regime is settled. For years, the central bank has devoted significant intellectual energy to assessing the merits of targeting a certain increase in the price level over time, rather than the actual rate of inflation. The tone of the central bank’s research suggested price-level targeting held promise.
Yet when the time came to renew the Bank of Canada’s mandate last fall, the Harper government opted against trying something new in the immediate aftermath of a recession. Mr. Carney’s comments in the Financial Times give reason to doubt that price-level targeting ever will be tried. Canada’s economic leaders appear to believe they have found the monetary policy equivalent of nirvana.
Mr. Carney dismisses the suggestion that central banks should raise their inflation targets temporarily to allow for more economic growth, describing it as “misguided.” It’s taken a few decades, but the public is now generally confident that central banks will contain inflation. Mr. Carney says that confidence is too precious to risk by arbitrarily lifting inflation targets. He says such a policy shift also would raise interest rates by causing investors to demand larger risk premiums.
Mr. Carney concedes that allowing temporarily higher inflation could work if policy makers adopted a new target, such as nominal gross domestic product. But again, he comes back to the risk of losing the public’s confidence. “The uncertain rewards of such a regime shift must be weighed against the risks of giving up what is arguably the most successful monetary policy idea in history: flexible inflation targeting.”
Canada was one of the first countries to embrace inflation targeting, and Mr. Carney’s article seems to ask the later adopters why they waited so long. The Federal Reserve and the Bank of Japan only recently identified inflation targets. Mr. Carney says those decisions “improves the effectiveness of their unconventional policies, and will be essential to manage their exit from those policies.”
It should be noted that while the Bank of Canada has worked with an inflation target since the 1990s, the emphasis on a “flexible” target is new. Canada’s central bankers likely always felt they could veer from the path of 2 per cent inflation if necessary. But it’s only in the aftermath of the crisis that the Bank of Canada has emphasized that it is not a slave to the inflation rate. That emphasis was born of necessity: higher commodity prices put upward pressure on inflation, yet the economy remained too weak to handle higher borrowing costs.
Which is precisely why Mr. Carney is so sensitive about maintaining the public’s faith in the central bank. Under a “flexible” regime, a central banker can say only one thing when he allows the inflation rate to detach from the stated target: trust me.