Canadians have good reason to be upset with Tiff Macklem. Even Tiff Macklem says so.
At the start of the year, the Bank of Canada expected inflation would be close to 2 per cent by the end of 2022. It’s roughly 7 per cent.
“That’s a very big forecast error,” the central bank Governor said in a year-end interview with The Globe and Mail. “So, yes, we have some explaining to do.” Outside the Bank of Canada’s Ottawa headquarters, a snowstorm raged, a fitting metaphor for the kind of year the 61-year-old has had.
When the year began, the bank maintained a record-low policy interest rate of 0.25 per cent, and an explicit pledge to keep it there until the pandemic-battered Canadian economy had returned to full speed. It ends the year with a policy rate of 4.25 per cent, a 15-year high.
In between, Mr. Macklem and his colleagues have raised interest rates seven times, as they race to cool an overheated economy in an effort to tamp down the highest inflation rate in nearly 40 years.
The bank’s chief responsibility is maintaining low and stable inflation. But the inflation rate this year is not just far above where the central bank thought it would be, it’s in a whole different orbit from the bank’s long-standing target of 2 per cent.
As inflation approached and then exceeded 8 per cent over the spring and summer, Mr. Macklem and his team responded with bigger and bigger rate hikes – including an increase of a full percentage point in July, the biggest single step up in almost a quarter-century.
“There’s no question, it’s been intense,” Mr. Macklem said. “And it hasn’t just been intense for me. It’s been intense for everybody at the Bank of Canada. But let’s face it, it’s been intense for every Canadian. Everybody’s lives have been hugely disrupted.”
As first inflation and then rates soared, Canadians have felt the sting of both. Housing values have slumped; mortgage costs have surged. Grocery prices are up 11 per cent year over year. Many households are stretched to their financial limits. The central bank has itself acknowledged that rate increases could tip the economy into recession.
All of this made Mr. Macklem the leading economic newsmaker of the year – and, to hear some people talk, a leading public enemy. Critics at both ends of the political spectrum have questioned Mr. Macklem’s motives and competence. He has faced accusations of acting too slowly on inflation, of irresponsibly fuelling inflation through the bank’s expansion of the money supply, of making workers and households pay the price for his mistakes with a devastating succession of rate increases.
Conservative Party Leader Pierre Poilievre wants him fired. Lana Payne, the president of the largest private-sector union in the country, Unifor, accused him of declaring a class war. Desjardins economist Randall Bartlett lampooned him in a seasonal broadside, “How the Governor Stole Christmas.”
Mr. Macklem isn’t alone. Central bankers around the world have faced a reckoning over how they misread the rise of inflation. And their tough response – one of the most rapid and globally synchronized monetary-policy tightening episodes on record – has drawn howls from investors and politicians alike.
Mr. Macklem used his last speech of 2022 – an event last week in Vancouver – to deliver something of a mea culpa to Canadians. As in that speech, his conversation with The Globe a few days later candidly discussed the bank’s policy stumbles and the reasons behind them, and acknowledged the pain that the aggressive rate policy is inflicting as the bank tries to get the inflation genie back in the bottle – while looking toward what he believes are brighter days ahead.
“Canadians are being harmed by inflation, they’re feeling the pain. They’re also feeling the strain of rapid increases in interest rates. They’re asking a lot of tough questions; their elected representatives are asking a lot of tough questions. I understand that,” he said. “They should be asking tough questions. They should expect a lot from their central bank.”
By the time the Bank of Canada’s July interest-rate decision rolled around, the bank had already raised its policy rate from 0.25 per cent to 1.5 per cent over the spring, in a race to put downward pressure on surging inflation. As Mr. Macklem and his colleagues weighed the economic data, it looked like they were losing that race.
June’s inflation rate was 8.1 per cent, up from 4.8 per cent when the year began. An already tight labour market had added another 220,000 jobs in the first half of the year. Gross domestic product expanded at a 3.3-per-cent annualized pace, far ahead of the rate of growth in the economy’s productive capacity.
Mr. Macklem responded with “the jumbo step” – a one-percentage-point increase. He then faced reporters to defend the decision, looking serious but surprisingly relaxed for a guy who was in a hot seat that just got a lot hotter.
“By the time I get to the moment, I’m actually remarkably calm,” he said, recalling that news conference.
Mr. Macklem typically spends the night before a rate announcement at home, poring over “the numbers” – revisiting the economic data and how it led to the decision that he and his team of deputy governors reached. This is the hard evidence that the bank uses to back up its rate moves, and he wants to make sure he knows it backward and forward before facing questions from the media.
The next morning, ahead of the announcement and news conference, he has some alone time to contemplate the implications of the decision from another perspective.
“I use that more just to sit back and think about, what’s on the minds of Canadians?” he said. “They’re not usually that interested in every wiggle. What they really want to know is, what does this decision mean for me? How is this decision going to affect my life?”
He’s guided by something that one of his predecessors as governor, Gordon Thiessen, preached to his staff when Mr. Macklem was an up-and-coming economist at the bank in the 1990s: Clear communication starts with clear thinking.
“Communicating monetary policy is not about having a cute line, a good jingle,” Mr. Macklem said. “It’s about having a clear story.”
But what Mr. Macklem has been communicating to Canadians in 2022 has been some awfully hard medicine to swallow. The bank misread a rising tide of inflation, reacted too slowly, and its message has shifted dramatically along the way. Clarity would not be the word that Mr. Macklem’s critics would choose.
The Bank of Canada’s experience is not unique. Central bankers around the world missed the mark on rising inflation through 2021 and early 2022. This episode is probably the biggest failure of monetary policy in the three decades that central banks have pursued inflation targeting.
So what went wrong?
Mr. Macklem has several explanations. One is that central bankers were essentially bowled over by events they couldn’t have predicted. Supply chain disruptions caused by COVID-19 proved harder to resolve than expected; the Omicron wave wasn’t followed by another spike in infections; Russia invaded Ukraine.
“If we’d known that there wasn’t going to be another wave, and that the economy would reopen rapidly, and that households would come very rapidly back into the market and try to catch up and buy so many of the services that they hadn’t been able to enjoy for the last couple of years – yes, I think if we could have foreseen that, we would have started to raise interest rates earlier,” Mr. Macklem said.
But inflation doesn’t get to 8 per cent by accident. The Bank of Canada’s economic models misread some crucial developments.
Central banks have tended to play down supply-side shocks when trying to gauge inflation. A drop in oil supply or a shutdown of factories can cause consumer prices to jump. But these jolts have tended to be short-lived – something that central banks “look through” rather than respond to with interest-rate increases.
Over the past two years, however, the global economy was struck by one supply shock after another – culminating with the war in Ukraine, which sent oil and food prices skyrocketing. And this occurred at the same time that central banks and governments were juicing demand with pandemic stimulus cheques and ultralow interest rates.
“What we didn’t see is just how many of these things there would be, and as the demand for goods really rose, those supply constraints started to become much more biting,” Mr. Macklem said.
Since it began targeting inflation in the 1990s, the bank had never faced a major supply shock at the same time that the economy was overheating. That combination allowed businesses to pass rising costs to customers much more rapidly than central-bank models predicted.
Some tools failed outright. The most egregious example is CPI-common, one of the bank’s “core” inflation measures, which is supposed to capture underlying inflationary pressures, particularly in the service sector. It’s a mathematical model that separates from each component of the Consumer Price Index the portion of its price change that it shares with all other components. It discards the portion that is unique to that single product or service.
CPI-common was the bank’s favourite metric for years. But it proved stunningly unreliable over the past year and a half. At the start of 2022, the CPI-common reading had barely inched above 2 per cent – a comforting sign for Mr. Macklem and his team at a time when headline consumer price inflation was above 5 per cent.
But as inflation evolved, Statistics Canada has revised CPI-common readings upward multiple times. Statscan now thinks CPI-common was actually 4.1 per cent in January, which means the economy was running far hotter than the Bank of Canada thought. Indeed, after revisions, CPI-common was running above the central bank’s 1-per-cent to 3-per-cent inflation target range as early as July, 2021.
Was CPI-common the broken compass that led the central bank astray?
“It certainly didn’t help,” Mr. Macklem said. “The fact that CPI-common really broke down, it’s kind of symbolic of the problem when you’ve got a big change in inflation and the whole behaviour of prices starts to change.”
As the year has progressed, Mr. Macklem and his team have become increasingly candid in acknowledging where their models went awry and where their forecasts sent them in the wrong direction. “Nobody’s ever going to get everything right. It’s important to learn from that,” he said.
Still, central banks aren’t automatons that adjust interest rates mechanically based on equations and incoming data. Central banking involves judgment and risk management.
The question dogging Mr. Macklem and other central bankers who oversaw the runup of inflation in 2021 and 2022 is not whether their models failed, but whether their judgment did. When asked if this was the case, Mr. Macklem answered haltingly.
“The course of history will have to decide,” he said. “We’re not through this yet.”
Former Bank of Canada governor Stephen Poloz, who stepped down from the bank’s top job in June, 2020, is reluctant to comment on his successor. But he does say that central bankers around the world have learned an important lesson over the past year about risk management.
“You never really know where your next shock is going to come from,” Mr. Poloz said in an interview. “And even though the [Bank of Canada’s] plan, I think, was exactly right, it had that risk to it. It had a risk that if some other shock came along, it could really do what has happened.”
Mervyn King, the former head of the Bank of England, is less charitable in his assessment of what central bankers around the world got wrong.
They failed to account for the inflationary impact of the expansion of the money supply during the pandemic, as central banks (including the Bank of Canada) engaged in quantitative easing and governments poured vast sums into the economy through income-support programs, Mr. King argued in a speech last month.
Because QE didn’t spark inflation when central banks used it during the 2008-2009 global financial crisis, central bankers became convinced that they could control inflation simply by pledging to defend 2-per-cent inflation targets.
“But the decisions made during the pandemic undermined that position,” he said. “Why would economic agents trust central-bank forecasts that inflation will shortly return to the 2-per-cent target when it has risen to 10 per cent?”
David Andolfatto, head of the University of Miami’s economics department and former U.S. Federal Reserve official, thinks that central bankers were lulled into a false sense of security because of the long period of low inflation after the financial crisis.
“We had just spent over 10 years undershooting inflation. We had spent 10 years at the Fed pre-emptively trying to raise rates [when signs of growing inflation pressures emerged], and it was always a mistake,” said Mr. Andolfatto, who was a schoolmate of Mr. Macklem’s at the University of Western Ontario.
With high inflation seemingly a thing of the past, central bankers became invested in the idea that they should allow economic recoveries to run a bit longer after damaging recessions.
“What the framework did not accommodate was the possibility of these supply shocks,” he said. “At the time, it was not so obvious.”
Mr. Macklem has more tough decisions ahead. After the dash to increase borrowing costs in 2022, monetary policy is nearing a pivot point. Instead of asking how big the next rate hike in January should be, Mr. Macklem and his team have said they’ll be discussing whether to raise interest rates at all.
It’s an airhorn signal to markets and central-bank watchers that the bank is nearing the end of its historic rate-hike cycle.
Still, Mr. Macklem is not quite ready to throw in the towel. In his speech last Monday, he took pains to point out that doing too little to fight inflation poses a “greater risk” than doing too much. That suggests a January pause in hikes is not necessarily the central bank’s base case.
“You certainly don’t want to overtighten. You don’t want to make this more painful than it has to be.” Mr. Macklem said. “You also don’t want to not do enough. You don’t want to be half-hearted. Because if we are, we’ll end up having to do more, and probably get a much sharper slowing of the Canadian economy to get inflation back down.”
It’s a tough balance, not least because monetary policy works with a considerable lag. Interest-rate increases can take 18 to 24 months to have a full impact on inflation. And rate hikes filter through the economy in phases: first squeezing rate-sensitive sectors such as real estate and auto sales; then hitting discretionary spending as mortgages are renewed at higher rates; and finally hitting employment and business investment.
The bank is forecasting near-zero growth through to the middle of 2023, and it expects unemployment to rise.
Inflation has begun to come down; it came in at 6.9 per cent in October. (The November data will be published Wednesday). The bank expects it to keep falling in the coming months, as many of the global factors that pushed up inflation – such as oil prices and shipping costs – have come down sharply in recent months. Its latest forecast shows inflation returning to 3 per cent by the end of 2023.
But getting all the way back to the 2-per-cent target won’t be easy, said Deloitte Canada chief economist Craig Alexander.
“The big issue is wages, and it’s not because the Bank of Canada is at war with workers,” he said.
“The problem is that as inflation falls, it could be the case that wage gains limit how far it drops. … So we might go down from the current rate of inflation to 3.5 per cent and then find that it’s really hard to get back to the Bank of Canada’s operational target of 2 per cent.”
Some economists have begun musing that the bank may need to raise its inflation target. Mr. Macklem shot down the idea when asked about it after his speech in Vancouver.
Even as snow pounded the streets surrounding Parliament Hill, Mr. Macklem ended the interview talking confidently about brighter days to come. He firmly believes that we’re about to see the bank’s aggressive rate hikes do the job that they are intended to do: bring inflation back under control.
“We’ve acted forcefully; it’s started to work. Once the snow melts, once spring comes, I do think you’re going to see core inflation start to really come down in a more meaningful way,” Mr. Macklem asserted.
If all goes as planned, the Governor is hoping to have a lower-key public profile by this time next year. You know monetary policy is working if the average Canadian doesn’t have to think about monetary policy.
“It’s going to be a difficult adjustment, and we’re going to be in the hot seat for a while,” he said. “But I think that as inflation comes down, and growth starts to resume in the second half of next year … I think I won’t be getting as much attention.”
“That will be a measure of success.”