The federal government has directed the Bank of Canada to put more emphasis on full employment as it aims to keep inflation low and stable. It is the most significant change to the central bank’s mandate in three decades, and reflects evolving ideas about the nature of the economy and monetary policy.
The central bank’s primary objective when setting interest rates remains stabilizing the value of the Canadian dollar by aiming to keep inflation around 2 per cent, within a range of 1 per cent to 3 per cent. But the bank’s new framework for targeting inflation also directs it “to actively seek the maximum sustainable level of employment when conditions warrant.”
That moves the Bank of Canada closer to a U.S.-style dual mandate – which seeks to maintain price stability alongside full employment – although it stops short of directing the bank to hit explicit employment targets. Maximum employment is defined as the highest level of employment the economy can sustain without driving runaway wage growth and increases in consumer prices.
The framework is the result of a mandate renewal process between the federal government and the central bank that happens every five years. This gives the government the opportunity to weigh in on the overall direction of monetary policy, which the Bank of Canada conducts on a day-to-day basis independent from government. The bank has been tasked with hitting 2-per-cent inflation since the mid-1990s.
Historically, mandate renewals have been a rubber-stamp process that takes place behind closed doors to little fanfare. This time, the renewal happened against the backdrop of galloping inflation that has run above the bank’s target range since April, hitting an 18-year high of 4.7 per cent in October. Inflation has become a top political issue, debated daily in the House of Commons, and opposition politicians are openly criticizing the Bank of Canada.
At a news conference after the announcement, Finance Minister Chrystia Freeland emphasized the continuity of the new mandate, saying it “represents the codification of existing practices” rather than a change in the direction of monetary policy. This was echoed by bank governor Tiff Macklem, who said the point of the new mandate was to provide “continuity and clarity.”
“This is the framework we need now as we confront elevated inflation and the challenges of reopening the economy. And it is what we need looking ahead beyond the pandemic,” Mr. Macklem said.
The focus on “maximum sustainable employment” is a major shift in the language of the mandate. However, it follows a change in the bank’s approach to labour markets over the course of the COVID-19 pandemic.
Since assuming the bank’s top job in June, 2020, Mr. Macklem has repeatedly emphasized the importance of an “inclusive” labour-market recovery that pulls workers from hard-hit sectors back into the work force. He has said inflation won’t stay sustainably at 2 per cent unless the economy is at full employment, and tied the timeline for interest-rate hikes to certain employment measures being achieved.
The bank has also begun looking beyond traditional labour-market metrics, such as the employment and unemployment rates, to assess the health of the job market. It now draws on indicators such as inclusion by age, gender and education.
“The reality is it’s the mandate catching up to where we are already,” Benjamin Reitzes, Bank of Montreal’s director of Canadian rates, said in an interview.
Mr. Reitzes said the new employment language is unlikely to have much of an impact on the bank’s monetary policy in the near term. However, he noted a heightened focus on the 1-per-cent to 3-per-cent inflation targeting band, as opposed to the 2-per-cent target, and said it could lead the bank to be more comfortable with slightly higher inflation over the long run.
“I guess they might be more tolerant of lower inflation, but I think the intent is to be more tolerant of higher inflation,” he said.
Derek Holt, head of capital market economics at the Bank of Nova Scotia, took a dim view of the changes to the framework, saying the new language muddied the water for investors trying to understand the direction of monetary policy.
“Overall, it would have been better to leave the wording unchanged in this sensitized, populist environment marked by concerns about governments seeking to more directly interfere in the operations of central banks. Central bank watchers already knew that labour conditions matter, but having governments lead a process to codify this is a bit insensitive toward market concerns,” Mr. Holt wrote in a note to clients.
Yields on short-term bonds fell after the announcement – a move that suggests investors view the new framework as more dovish than the one it replaces. The bank has signalled that it will begin hiking its overnight rate in the middle quarters of next year, although there is uncertainty about how early these interest-rate increases will start.
Both Mr. Macklem and Ms. Freeland were at pains in the news conference to say the new employment language in the monetary policy framework does not mean the bank has adopted a dual mandate. Low, stable and predictable inflation remains the bank’s paramount concern, they said. Any attempts to test how low unemployment can go will be conditional on inflation remaining in check.
“With respect to this idea of actively seeking, or probing for maximum sustainable employment ... that’s something to do when inflation is close to target, interest rates are at more normal levels. That’s not the situation we’re in right now,” Mr. Macklem said.
While the new framework speaks about the importance of maximum employment, it does not try to define it. The renewal agreement states that full employment is “not directly measurable and is determined largely by non-monetary factors that can change through time.” This is an important caveat and an argument against trying to hit an explicit employment or unemployment target when conducting monetary policy.
Bank policy makers have argued in recent months that maximum employment has become harder to estimate owing to technological and demographic changes, compounded by severe labour-market disruption in the pandemic. Moreover, the traditional relationship between unemployment and inflation – low unemployment is connected to high inflation, and high unemployment is connected to low inflation – has grown weaker, making it harder to accurately define full employment.
The mandate renewal process was the most ambitious the bank has undertaken in three decades, involving years of research and extensive public consultation. The bank considered five alternative monetary policy frameworks to see if any could do a better job controlling inflation and promoting other economic goals, such as full employment or robust GDP growth.
The leading alternatives to the status quo were a dual mandate and an average inflation targeting framework, which would aim for higher inflation after recessions. The U.S. Federal Reserve has had a dual mandate since the 1970s, and adopted a form of average inflation targeting last year.
The Bank of Canada decided not to follow the Fed in adopting average inflation targeting. It did, however, acknowledge in its joint statement with the government, that in some circumstances, it would likely hold rates “at a low level for longer than usual.”
This is because interest rates around the world have been declining over the past 20 years for reasons relating to demographics, patterns of savings and investment, and technological change. That means the central bank is more likely to run into situations where it can’t cut interest rates as much as it needs to. Keeping rates low for longer is one response to this problem.
NDP finance critic Daniel Blaikie said in a statement that the renewed mandate “won’t provide relief for Canadians struggling to get by.” Conservative finance critic Pierre Poilievre said in a statement that “the government should end its politicization of the central bank and return its focus to its principal job: low inflation and sound money.”
The joint statement between the government and the central bank highlighted several issues that are often seen as outside the scope of monetary policy, including the importance of addressing inequality and the risks of climate change. The new framework, however, stops short of giving monetary policy a direct role in promoting a green energy transition. Over the past year, other central banks, including those of Europe and Japan, have been given a more explicit role in combatting climate change.
With a report from Bill Curry
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Mark Rendell