For more than five years as head of the Bank of Canada, Stephen Poloz has talked about bringing the Canadian economy “home” from its long journey through the postfinancial-crisis wilderness. But after another year of intermittent progress undermined by setbacks and uncertainties, home remains, frustratingly, just over the next hill.
“It’s been a very trying year,” the central bank’s Governor acknowledged in his third annual end-of-year interview with The Globe and Mail. “I would say if we got somewhere, we got there despite a number of curveballs, or a number of things that were thrown at us. Over all, my level of satisfaction is pretty good, but I can’t feel satisfied when things aren’t all the way home.”
“We’ve still got some work to do.”
For Mr. Poloz, “home” is that cozy place where the economy is running at full capacity and inflation is at the bank’s 2-per-cent target. A year ago, the central bank Governor confidently asserted that we’re “quite close to home, and getting closer." And indeed, a lot of things fell into place for Mr. Poloz and his Bank of Canada colleagues in 2018.
With inflation indicators stabilizing around the bank’s target, the economy growing solidly and unemployment at 40-plus-year lows, the bank had the all-clear to raise interest rates three times during the year, lifting its key rate from 1 per cent to 1.75 per cent. It got there in spite of a steady barrage of uncertainties throughout the year: North American trade negotiations, steel and aluminum tariffs, U.S. tax cuts, Brexit and oil-pipeline delays all complicated the central bank’s job.
As recently as two months ago, Mr. Poloz talked cheerily about how the economy was back. He laid out a plan to normalize the bank’s key interest rate, getting it back up to a neutral range – somewhere between 2.5 per cent and 3.5 per cent, by the bank’s estimation – where monetary policy is neither driving growth higher, nor slowing it down.
It turns out we are not home yet – and perhaps we won’t be for a while. A dramatic fall in the price of Canadian crude oil caused Mr. Poloz and his colleagues to seriously rethink their economic narrative in their early December interest-rate announcement. The bank has replaced some of its bolder rhetoric with a sharp note of caution heading into 2019. The economic outlook is suddenly uncertain. Rate hikes are on hold for now. Getting home will have to wait – again.
“It just seemed like every week, there was something else to throw off your analysis,” Mr. Poloz says. “I suppose there’s a sense of frustration about it.”
The abrupt shift in tone is a source of frustration for many central bank watchers and market participants, too. They argue the bank seemed overly optimistic in mid-October, even as the sharp plunge in the price of crude was well under way. That forced the Bank of Canada to retreat just six weeks later, dialling back expectations that the bank would eventually push its key interest rate as high as 3.5 per cent.
“It only really got odd in October,” agrees Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce. But bank officials “seem to have corrected themselves” with the step-back in the message in December, he adds.
If people were surprised by the about-face, then so be it, Mr. Poloz says. For months, he’s been telling anyone listening that the bank is data dependent. That works in both directions. Sometimes the economy runs faster than expected; sometimes, slower.
“If people thought that meant it could only mean faster, then that’s their problem,” he says defiantly.
Mr. Poloz wasn’t alone in being taken aback by the shifting environment this fall. Prospects for the Canadian economy seemed to be looking up in mid-October, particularly after the successful renegotiation of the North American free-trade agreement. But just as one cloud lifted, more gathered. In addition to slumping oil prices, the world has become increasingly nervous about the U.S.-China trade feud. Britain’s Brexit deal to cordially extract itself from the European Union teeters on the brink. The global economy has been showing signs of losing momentum under the mounting risks.
“It seems as if [the Bank of Canada] had decided a lot of the uncertainties had resolved themselves,” says economist Steve Ambler, a professor at Université du Québec à Montréal. “But that turned out not to be the case. Can you really blame them for that?”
Mr. Poloz is dealing with a range of challenges, some geopolitical and others more structural, says Prof. Ambler, who sits on the C.D. Howe Institute’s Monetary Policy Council. Wage gains, he says, have remained stubbornly slow even as the unemployment rate has continued to fall. All that is complicating the bank’s efforts to get inflation back up to its 2-per-cent target.
On the other hand, Mr. Poloz and his team are still seeing positive signs of an economy, outside the oil sector, that’s running near full speed and is poised for a burst of growth-fuelling business investment. Friday’s quarterly Business Outlook Report, an important gauge of the corporate sector’s temperature, showed that businesses are only slightly less optimistic about their sales, investment and hiring prospects because of the turmoil in the oil patch.
“Our expectation is that business investment outside the energy sector will be stronger next year,” Mr. Poloz says. “Of course the oil patch is going through a rough time and that means probably a decline in investment there, but for the economy as a whole, businesses appear to be confident enough in their future prospects to sink money into expansions.”
Despite the fall hiccups, Mr. Poloz thinks the central bank is doing a better job of getting its message out to financial markets, and Canadians more broadly. The bank’s new practice of scheduling speeches by top bank officials immediately after all rate announcements – even those that don’t coincide with the release of new quarterly forecasts – has helped.
He smiles when asked whether, after more than five years, the markets “get Steve Poloz” now.
“I hope so," he says. "It feels like they do.”
The Bank of Canada wanted to move from giving the market explicit guidance about the direction of rates to a situation in which it is watching economic developments alongside investors, borrowers and savers. It wasn’t always a smooth transition, Mr. Poloz acknowledges, but he says it’s working better.
“It was a learning process for all of us,” he says. “It’s about helping the market to understand. But it’s really about helping all Canadians to understand better what we are doing and why.”
The key, he says, is that Canadians continue to have faith that the central bank is committed to low inflation, and that they trust the central bank to get the economy back to balance.
Some of that boils down to people knowing what economic indicators the Bank of Canada is focusing on to find that balance. On that front, Mr. Poloz says the clearest signals of when the economy has, finally, reached full capacity will come from the labour market. Despite strong employment growth and historically low unemployment, stubbornly tepid wage gains are a sign that we’re not there yet, he says.
“That would be one of the things that you would expect to see before you got home: Wages would be growing faster.
“As we approach full capacity, what we always have expected is that the churn in the labour market will pick up more. People will switch jobs more – you’ll trade up,” he explains.
“Through churn, people not only find a job where they are more productive, so productivity goes up, they find a job that pays more, so wages jump up," he says. "Economic growth would go up – and supply would go up with it. So it wouldn’t be inflationary. You would also see [company] creation picking up more strongly in that setting.”
“All of those are sort of the tick marks that I look for, when you ask about the signs that you’re getting close to home,” he says. “It’s that stage of our recovery that has not really started to emerge.”
Related to the question of how close the economy is to full capacity is how far away we are to a “neutral” interest rate, in terms of both what level that rate might be and how long it will take to get there. It’s a key question for financial markets, as well as borrowers and lenders – and one around which confusion has arisen ever since the Bank of Canada started talking about returning to neutral in its October rate announcement.
The neutral rate is the elusive Goldilocks of interest rates – the rate at which the central bank is neither stimulating nor slowing the economy. It’s where any central bank would, in a perfect world, like to end up to maintain its economy at full potential and its inflation on target. And despite the bank’s shift to a more cautious tone in its December rate announcement, it still says rates “will need to rise into a neutral range to achieve the inflation target.”
When asked in a news conference earlier this month whether it was possible the neutral rate could be lower than the bank’s estimated 2.5 per cent to 3.5 per cent, Mr. Poloz suggested the difference between 2 per cent and 2.5 per cent amounted to “a rounding error.” His comment was taken by some observers as a hint that the Bank of Canada is closer than previously thought to reaching neutral – and thus ending its current rate-hiking cycle.
Mr. Poloz says there is considerable misunderstanding surrounding the bank’s neutral-rate estimate. He clarifies that the 2.5-to-3.5-per-cent “range” really represents a variety of estimates using different statistical methods, and each of those estimates has its own margin of error.
"The point is, you shouldn’t attach a lot of precision to any one of those numbers,” he says.
“We really won’t know what’s ‘neutral’ until we’re there – we won’t be able to detect any headwinds, and we won’t be able to detect stimulative effects or any contractionary effects [from interest rates]. And there are just too many unknowns.”
“I’m not being evasive. I’m just telling you the honest truth – we won’t know, really, until we get closer to it. Right now, we just have other data to watch.”
One issue that has remained on Mr. Poloz’s radar screen throughout his tenure is the record household debt of Canadians. In recent months, Bank of Canada officials have struck a more optimistic tone about the problem, pointing to slowing consumer borrowing and the cooling of the once-overheated Toronto and Vancouver real estate markets.
But a legacy of debt still hangs over the economy. Canadians now owe $1.78 for every dollar of income they earn. In the country’s priciest cities, many borrowers are even more stretched, and vulnerable. In a sobering report this month, Citigroup put Canada among a clutch of countries at risk of a financial crisis in three years because of stresses from high household debt.
Mr. Poloz insists the debt problem remains one of his top concerns. He says the bank is closely tracking how Canadians are coping with higher interest rates – even down to the level of tracking anonymous data on the vast majority of new mortgages issued in the past four years.
“Am I worried about the stock of debt? Of course I am,” Mr. Poloz said. “We have a lot of individuals with a high level of debt and facing the potential renewal of their mortgage at a higher interest rate.”
Queen’s University economist Donald Drummond notes that while central bankers are right to be concerned about debt, it’s also a problem they helped create.
“The debt problem was largely caused by their very low interest rates,” Mr. Drummond says. “They had a rationale for them at one point, but that rationale is gone.”
Some problems clearly won’t get fixed on Mr. Poloz’s watch. There are now just 18 months left in his seven-year term – not a lot of time, in central banking terms, to overcome all the setbacks and fulfill his pledge to finally bring the economy home. He can hear the clock is ticking.
“When I first came back to the bank in 2013, I honestly thought within a couple of years, we would be at home, or close to home,” he said. “We got reasonably close, but then the [2014-15] oil shock was a major detour, a three-year detour. So that’s how you get up to five years’ time passed, and you’re still not quite home.”
Will he consider his work unfinished if the economy hasn’t reached home by the end of his term?
“I possibly will.”