At the Jackson Hole economic policy conference in August, 2009, Bank of Canada Governor Mark Carney stood in front of some of the world’s most esteemed economists and said this:
“It is important that markets understand how a central bank formulates policy, but that does not equate to perfect foresight. Differences in judgment and the fundamental uncertainties surrounding the economic outlook should mean occasional differences in view. These should be particularly marked during turning points in the economic cycle. As the review of liquidity cycles suggests, wider ‘markets’ in expected economic outcomes (which would mean greater short-term volatility) could promote long-term financial stability.”
More than a few market participants are grumbling about the Bank of Canada’s “confusing” communications policy. No need to name them. The dollar’s zigzagging shows a fair number of folks have lost some money by trying to figure out whether the central bank is “hawkish” or “dovish.”
How about neither? Or as Mr. Carney put it at a testy press conference Wednesday in Ottawa: “It is what it is.”
Central bank watchers have a tendency to overanalyze their subjects. Much was made of the omission of a stock phrase on the need to eventually raise interest rates from Mr. Carney’s speech in British Columbia last week. Conclusion: policy makers had become spooked by the global economy and were backing off plans to raise borrowing costs. This became the consensus view ahead of the central bank’s policy statement Tuesday.
Those who joined the consensus forgot Mr. Carney has showed little interest in word games since taking over the Bank of Canada in 2008. Mr. Carney’s speech came just as central bankers were beginning their week-long deliberations over policy; front-running that discussion just isn’t something the governor would do. To understand why, consider the policy shift that was the result of those deliberations. After running the numbers, policy makers saw that an interest-rate increase wouldn’t be as needed as soon as they had thought earlier this year. Now consider how markets would have reacted if Mr. Carney had repeated the central bank’s stock guidance, only to learn a week later that the central bank actually was less inclined to raise interest rates in the near term?
Now, it’s possible the Fed’s conditional pledge to keep borrowing costs extremely low well into 2015 is causing some envy among Bank of Canada watchers who would appreciate similar certainty.
But Mr. Carney made an important distinction Wednesday by pointing out that the Fed’s communications policy is an “exceptional” policy response necessitated by exceptional circumstances. In Canada, the economy is growing, the unemployment rate is at an acceptable level and the central bank’s benchmark rate is at 1 per cent, not zero.
Mr. Carney wants financial markets to judge the trajectory of interest rates by assessing the state of the economy, not by trying to read his mind. That’s because Mr. Carney lacks, as he put it in Jackson Hole, “perfect foresight.”
Policy should change as economic conditions change. That didn’t happen ahead of the financial crisis, at least to the degree it should have. If more investors had been watching economic and financial indicators instead of the thickness of Alan Greenspan’s briefcase before Fed policy meetings, the damage from the crisis might have been mitigated.