Tiff Macklem eyes the other side of the crisis: balancing inflation risk with an inclusive recovery

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Thirteen months into a pandemic and 11 months into Canada’s top central banking job, Tiff Macklem can almost see the other side of the crisis.

The Canadian economy powered through a second round of lockdowns earlier this year. COVID-19 vaccinations are picking up pace. The end of the central bank’s extraordinary supports to help see the country through the pandemic is now in sight, albeit on a still-distant horizon.

“We still have considerable ways to go. But it’s working,” Mr. Macklem told The Globe and Mail in an interview this week. “Canadians are finding new ways to work. They’re finding new ways to shop. Businesses are finding ways to serve customers.”

Since becoming Bank of Canada governor last June, Mr. Macklem’s main job has been guiding the economy through waves of COVID-19 infections, lockdowns and business closings. That largely meant continuing the emergency stimulus measures launched by his predecessor, while promising not to raise interest rates for several years.

Now, with the bank formally acknowledging this week that the economy is much further down the path to recovery than it had previously estimated, the governor enters a delicate phase of policy making. As he begins to unwind the massive monetary stimulus the bank has put in place to prop up the economy and accelerate the recovery, he must weigh that task against both rising inflation expectations and a desire not to leave COVID-19′s economic casualties behind.

On Wednesday, Mr. Macklem made his first significant move. The bank announced it would slow its pace of buying government bonds, known as quantitative easing, or QE, by 25 per cent, to $3-billion a week. It brought forward its guidance on timing for a potential rate hike to 2022 from 2023. The moves put the Bank of Canada well ahead of the U.S. Federal Reserve and other major central banks in beginning to unwind extraordinary pandemic supports.

At the same time, though, Mr. Macklem signalled that he’s willing to let inflation run a little above the bank’s long-standing 2-per-cent target as he looks to foster a more complete, inclusive recovery.

Mr. Macklem has said he’s aiming for a broad-based recovery that not only grows the economy and brings inflation sustainably back to the bank’s 2-per-cent target, but also brings those hurt most by the pandemic – such as low-wage workers, women and young people – back into the work force.

“The reality is we are looking at labour markets at a more granular level than we typically do, and that really reflects the reality that this crisis is having very unequal effects across the labour market,” Mr. Macklem said.

Recent job gains have been impressive, with more than 300,000 jobs added in March, bringing the unemployment rate down to 7.5 per cent from 13.7 per cent in the depths of the pandemic. But aggregate jobless numbers hide the fact that employment for low-wage workers remains 20 per cent below prepandemic levels.

“We’re also going to be looking at the participation rates, particularly of these most affected groups. I mean if the unemployment rate comes down because workers become discouraged and drop out of the labour force, well that’s not a full recovery,” Mr. Macklem said.

Mr. Macklem candidly acknowledges the bank can’t achieve that objective without substantial help from fiscal policy – the government’s spending and taxation commitments in support of the recovery. Last week’s central bank actions came just two days after the federal government unveiled $101-billion in additional stimulus over the next three years.

“Monetary policy has its tools, but we can’t target individual groups. Given the unevenness of this crisis, there is a need for fiscal measures,” he said.

“Knowing that all the tools are being used is certainly reassuring.”

“One thing you could say about [Mr. Macklem] is that he’s not wrapped in dogma by any means. He’s showing a certain flexibility,” said Queen’s University economist Don Drummond, a veteran of Ottawa’s policy circles.

“He’s willing to have a broader interpretation of what full capacity might mean,” Mr. Drummond said.

Based on improving economic data, the bank has adjusted its timing for a potential rate hike to 2022. But Mr. Macklem stressed that this does not guarantee a rate hike next year.

“Our message here is that we’re going to be patient,” Mr. Macklem said. “We’re looking at a broad set [of indicators]. We’re going to be assessing that in real time, and we’re not going to be pulling forward what we think is going to happen.”

Achieving the bank’s goals will require a deft hand on the levers of monetary policy. If it holds interest rates down and continues QE for too long, inflation could become a problem, as could the overheating housing market. If it applies the brakes too quickly, it could leave behind segments of the economy and work force before they get back on their feet.

Part of this balancing act emerged this week in Mr. Macklem’s willingness to let inflation – the guiding target of Bank of Canada policy for nearly three decades – run a bit hotter than usual while the bank pursues this vision of an inclusive recovery. That was implicitly acknowledged in the bank’s new economic projections, which see inflation at 2.4 per cent by the end of 2023, well above the 2-per-cent target.

Officially, the bank has an inflation target band of 1 per cent to 3 per cent, with the midpoint serving as a precise objective, and Mr. Macklem is prepared to make use of that wiggle room.

“That was a very deliberate, calculated decision. We were faced [over the past year] with the situation where inflation was very low, we had a lot of excess supply. Our major concern was deflation, or inflation that was far too low. By providing that exceptional stimulus, that’s helpful in getting inflation back to the target faster,” he said.

“If that means we go a little over the [inflation] target for a period, that is definitely a risk worth taking.”

The approach bears some similarity to the new mandate that the Federal Reserve adopted last year, in which it now pursues an average inflation rate over time. If inflation runs below its 2-per-cent target, the Fed will purposely let it run hot to make up for the miss.

“I think the Fed has been more honest in this regard,” Bank of Nova Scotia economist Derek Holt said, noting that Fed chairman Jerome Powell has been quite upfront about targeting an overshoot in response to low inflation during the pandemic. Mr. Holt said the Bank of Canada has been less candid on this front, but may now be signalling it wants to bring such thinking into Canadian inflation expectations.

Concerns about rising inflation roiled financial markets in recent months, as traders and economists have debated whether policy is not only falling behind the inflationary curve as the economy recovers, but is actually adding fuel to the inflationary fires. It’s far from the only criticism Mr. Macklem has faced as the bank’s extraordinary economic supports enter their second year.

The Bank of Canada’s purchases of more than $250-billion in federal government bonds over the past year have led to accusations it has enabled the federal government’s massive deficits, distorted the bond market and compromised its political independence.

Meanwhile, housing-market pundits routinely point at the central bank’s record-low interest rates as the chief cause of the current frenzy in home demand and soaring prices – which, some argue, has put the financial well-being of homeowners at risk.

Yet Mr. Macklem pushes back at the suggestion that the central bank has strayed from its appropriate role in the crisis, or that it has reputational damage to repair.

“I think we’ve been very clear from the start that we are guided by our inflation target, and the actions that we take have been taken to support recovery, get Canadians back to work, so that we hit our inflation target,” he said.

“And we have demonstrated that when programs are no longer needed, we will wind them down.”

Mr. Drummond argues that this will be the most pressing task ahead for the governor – to chart a path to normalizing monetary policy as fast as reasonably possible. The Bank of Canada’s key interest rate of 0.25 per cent is roughly two percentage points below the bank’s own estimate of what it considers a neutral level. Even if rates start climbing as expected more than a year from now, they will still be highly stimulative and enticing to borrowers for a long time.

“Monetary policy is designed that when there’s a problem, you get in big and you get out quick. It wasn’t designed to be away from neutral by a substantial margin for a very long period of time, because that in itself creates imbalances,” Mr. Drummond said. “I think the longer we hammer savers and incent borrowers, the worse those imbalances are going to be.”

But Mr. Macklem is quick to remind his critics that, first and foremost, we have to get past the pandemic and its profound damage.

“The number one priority is getting a complete recovery,” he said. “The good news is we are making progress, but we still have some way to go, and it’s going to take some time.”

“We’re not going to count our chickens before they hatch.”

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