Why is Macklem indifferent to Statscan’s inflation shift?

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Statistics Canada took a pratfall this week on some key inflation calculations, and it couldn’t have come at a much more inopportune time. So why doesn’t Bank of Canada Governor Tiff Macklem – whose central responsibility is all about inflation – sound more bothered?

In a news conference Tuesday, Mr. Macklem emphatically shrugged off Statscan’s decision to abandon methodological changes to two key measures of core inflation, just days after those changes were introduced to the consternation of many economists, including those at the central bank. He said the statistical agency’s backtracking won’t have “much of an impact” on his inflation views.

The gauges involved are hardly inconsequential to the Bank of Canada. They are two of the three core measures that the central bank hand-picked in 2016 to help it better track the economy’s underlying inflation trend. And as a result of Statscan’s methodological flip-flop, the average of those three measures for January jumped from a lower-than-expected 1.5 per cent to a higher-than-expected 1.8 per cent. The two revised core inflation benchmarks now both sit smack-dab on the central bank’s 2-per-cent target.

The misstep comes at what appears to be at a pivot point in North American inflation expectations. Financial markets have awoken to the risk of faster-than-expected acceleration in prices, as an end to the COVID-19 pandemic appears on the horizon. Economists are increasingly talking about the inflation risks that could emerge in the recovery. Speculation has grown over how soon central banks, including Canada’s, will be forced to turn down their monetary taps and, eventually, turn up interest rates.

In a pandemic-distorted environment that has made consumer inflation a particularly elusive indicator to accurately capture, no one needed this statistical curveball.

But Mr. Macklem’s nonchalantness says a lot about what really matters to the central banker in the inflation picture. And it’s not the point-by-point specifics of unpredictable and often questionable data that COVID-19 keeps spitting out. That’s comforting on some levels, and a bit disturbing on others.

The governor’s mantra for months now – repeated in his speech that preceded Tuesday’s news conference – is that the economy is operating far below capacity, employment is still in a deep hole and it will be a long, slow process to return to full speed. That’s plainly evident in all sorts of other economic indicators – most prominently, labour force figures that show employment down more than 850,000 from prepandemic levels.

For the central bank, inflation is generally only problematic if it’s a product of an economy approaching full capacity and a labour market approaching full employment – that is, if the inflation represents an overheating economy. Otherwise, even if the year-over-year inflation rate exceeds the bank’s formal 2-per-cent target – as it almost certainly will in the coming months, as the year-over-year comparison will soon swing to the deeply depressed prices for energy and some other products in the depths of last spring’s lockdowns – the central bank considers it a whole lot of transitory noise.

In any event, it’s pretty clear that Mr. Macklem isn’t sold on the signals that those upwardly revised core measures are giving off.

“The ‘common-component’ measure of core [inflation] remains at 1.3 [per cent]. Total [inflation] is at 1 [per cent],” he said.

Mr. Macklem’s comments reinforce a long-standing perception in many quarters that among the three core-inflation gauges, the common-component measure is the bank’s favourite. This measure – a fairly complex statistical model that hones in on only the portion of price changes that is shared in common across all items in the consumer price index – has been both lower and generally more stable than the other two (called the “median” and the “trim”) throughout the pandemic. It has remained between 1.3 per cent and 1.5 per cent – giving off nary a whiff of rising inflationary pressures.

Nevertheless, this episode underlines that the crisis has made inflation a particularly hard nut to crack – to the point where looking through and past inflation readings has been routinely more important than looking at them. While that’s a healthy thing for a central banker to do from time to time, it threatens to cast a problematic fog over some very important decisions as the recovery gains steam.

Inflation control is at the foundation of monetary policy decisions at the Bank of Canada, as it is for most central banks; it will be pivotal to determining the timing of the tapering of bond purchases under quantitative easing and the eventual rise of interest rates. It won’t be so easy to shrug off inflation data when we come to crunch time on those decisions. Yet there’s little doubt that the numbers will remain distorted by the fallout from the pandemic for some time.

Central bankers often talk about monetary policy being data-dependent. In the coming months, on the inflation front, they may have little choice but to keep their thinking data-independent. It won’t be easy.

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