Stimulating the economy was easy. Taming inflation will be much trickier.

If you’ve been in the market for a new refrigerator in recent weeks, you’re likely still suffering from sticker shock. Fridge prices were up almost 14 per cent in December, as Canada’s overall inflation rate hit a 30-year high of 4.8 per cent. Everything is suddenly costing more, from that fridge and the groceries you put in it (up 5.7 per cent) to a new car (7.2 per cent more) and the gas (33 per cent) it likely runs on. From home insurance (9.3 per cent) to shelter costs (5.4 per cent), Canadians are forking out more and more of their income just to cover the basics.

Some very smart folks insist this nasty spike in prices is a nice problem to have.

“We should be celebrating that we didn’t have deflation. We didn’t have a depression. It could have been a vastly worse outcome,” former Bank of Canada governor Stephen Poloz told The Globe and Mail last month. “If, today, inflation risks seem slightly skewed, that’s a small price to pay.”

Mr. Poloz was at the helm of the country’s central bank when the COVID-19 pandemic struck and lockdowns hit the economy like a Mack truck. No one knew what to expect, just that none of it would be good. As the jobless rate soared within days to nearly 14 per cent, from less than 6 per cent, the scenarios ranged from a protracted recession to a once-in-a century depression.

Policy makers decided then to take “unprecedented” action to address an “unprecedented” crisis: They embarked on the biggest economic stimulus exercise outside of wartime, flooding the economy with so much liquidity that even the most rickety boats were lifted.

Ottawa sent out “free money” to almost anyone who asked for it. And the Bank of Canada, after slashing short-term interest rates to almost zero, began hoovering up government bonds under the guise of “quantitative easing.” That drove down long-term rates, lighting a fire under the housing and stock markets, and enabling Ottawa to borrow on the cheap.

It worked. Perhaps too well. Mr. Poloz’s successor as central bank governor, Tiff Macklem, now faces the much trickier task of turning off the taps without throwing the economy into a tailspin. Most Bay Street economists expect the Bank of Canada will begin raising interest rates next week, with the first of several rate hikes in the coming months, to bring the inflation rate back within the bank’s target range of between 1 per cent and 3 per cent.

Mr. Macklem’s counterparts in the United States, Britain and Europe are facing the same dilemma. Critics argue central bankers have waited too long to address the inflationary pressure they helped create, setting their economies up for a painful reckoning as investors turn their attention to the massive debts governments have run up during the pandemic.

For months, Mr. Macklem and U.S. Federal Reserve Board chairman Jerome Powell insisted rising inflation was a “transitory” phenomenon caused by global supply chain bottlenecks. They have mostly dropped that narrative in recent weeks amid mounting evidence to the contrary.

Even if snarled supply chains are in part responsible, extraordinarily loose fiscal and monetary policies have served to artificially raise demand for everything from fridges to houses. Labour shortages are forcing businesses to raise wages, passing on the extra cost to consumers.

The U.S. inflation rate hit 7 per cent in December and Mr. Powell said last week that the Fed will need to take action soon “to prevent higher inflation from becoming entrenched.” His comments were a reversal from previous messaging that suggested the Fed would keep interest rates near zero until 2024. That has put added pressure on the Bank of Canada to act now.

Raising short-term lending rates without tanking the economy is not the only tricky move Mr. Macklem must execute in the coming months. He will need to begin reducing the size of the central bank’s balance sheet by selling off some, if not most, of the more than $430-billion in Government of Canada bonds it now holds. The central bank now owns more than 40 per cent of outstanding federal bonds. That has contributed to the perception in markets that it has been financing Ottawa’s record deficits, which, in the longer term, is a recipe for disaster.

Shrinking the bank’s balance sheet would force a much-needed measure of fiscal discipline on the federal government. It would also have the effect of raising longer-term interest rates, which more directly affect mortgage rates.

The central bank underwrote the housing boom with its bond-buying program – house prices rose 26 per cent in 2021 alone. Rising long-term rates could turn that boom into a bust virtually overnight. The consequences would be nothing short of catastrophic for an economy as hooked on housing as Canada’s.

In the end, the price to pay for those “slightly skewed” inflation risks that Mr. Poloz not so long ago dismissed may not be so small. But that’s Mr. Macklem’s problem now.

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