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In early 2020, the Bank of Canada’s benchmark interest rate was 1.75 per cent. Then came COVID-19.

On March 4, the central bank slashed rates by a half-point. On March 13, it cut another half-point. Two weeks later, with Canada in lockdown, the bank cut again, moving its rate to 0.25 per cent – the “effective lower bound,” a.k.a. pretty much zero. The same day, the central bank announced its first-ever foray into quantitative easing, a plan to buy at least $5-billion of Government of Canada bonds each week.

Alongside the bank’s monetary policy firehose, the federal government embarked on an unparalleled fiscal stimulus, giving tens of billions of dollars to unemployed Canadians and idle businesses.

The goal was preventing a deep and self-reinforcing recession, which would have happened if millions of jobless workers had been left with no money to spend, leading to even more business closures, leading to even more layoffs.

The plan worked.

With extra money in the pockets of consumers, Canada’s economy bounced back quickly in 2021, so much so that the employment rate of core working-age people in December was 84.2 per cent – a percentage point higher than before the pandemic.

It’s painful. But the sooner we reduce inflation, the better

The plan was always to unwind emergency measures as the economic emergency wound down. The Bank of Canada stopped buying new government bonds last October. Ottawa’s deficit has been more than halved and the government says it will return to prepandemic levels within three years.

One lever that has gone untouched is the central bank’s benchmark interest rate. A lot of people are calling for it to be pulled, and hard.

On Wednesday, Statistics Canada said the headline inflation rate in December was 4.8 per cent, slightly higher than in November, which was already the highest since the early 1990s. The average of three core inflation measures, used to adjust for short-term volatility, was 2.9 per cent. That’s not a crisis, given the bank’s target inflation is the midpoint of 1 per cent to 3 per cent. But it, too, is at a three-decade high.

There’s inflation everywhere, from food to refrigerators. But much of it is powered by things that aren’t easily corrected by raising interest rates – things such as high oil prices and global supply chain crunches. Higher interest rates won’t unclog the Port of Long Beach in California or lower the global price of crude.

Higher rates might not even have much effect on overheated Canadian housing, where at least part of what’s driving prices is a lack of long-term supply. According to modelling by the British Columbia Real Estate Association, even if the Bank of Canada hikes its rate to 1.75 per cent, it would have only a “minor impact” on prices.

To the extent that current policy may be too stimulative, much of that stimulation is coming from the fiscal side.

As the Parliamentary Budget Officer said on Wednesday, looking at the Trudeau government’s plans for additional stimulus in a largely recovered economy, “the government’s own fiscal guardrails indicate that stimulus spending should be wound down by the end of fiscal year 2021-22. It appears to me that the rationale for the additional spending initially set aside as ‘stimulus’ no longer exists.”

In other words, though gradually higher interest rates are surely necessary in the year to come, and may even be necessary right now, today’s price increases are partly, and perhaps even largely, driven by causes having nothing to do with interest rates.

It is now widely expected that the Bank of Canada will make its first move to raise rates next week, though given the uncertainty around Omicron, it may hold off. Either way, the extent to which domestic inflation is being driven by global supply shortages, blocked supply chains, a lack of new housing and ongoing fiscal stimulus suggests that tempering inflation is about a lot more than the timing of the bank’s next rate decision.

The economic and social tumult of the past two years could have turned out a lot worse. Radical monetary and fiscal interventions inoculated the economy. Canada overcame the threat of deflation, and it did so by using more than just monetary policy – in fact, the most powerful response came from fiscal policy.

The current challenge is inflation. And in its current form, it’s about a lot more than just interest rates.

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