Mark Carney, governor of the Bank of Canada, listens to a question from a delegate during the Canadian Financial Forum in Beijing, China, on Aug. 12.Andy Wong
Bank of Canada governor Mark Carney is giving broad hints he wants an expanded mandate to prevent future financial meltdowns beyond acting as the country's inflation cop.
The G-7's youngest central banker laid out his views on the current financial and economic crisis before key policy makers from around the world Saturday and he warned that strictly targeting inflation, while useful, may not be enough to prevent future meltdowns.
In fact, he says, central bankers may have done too good a job of keeping inflation in check for too long, giving cowboys on Wall Street the false sense of security to take disastrous risks.
"There is an emerging consensus that price stability does not guarantee financial stability," he said in the prepared text of his remarks released by the Bank of Canada to the media.
"As we have all just been reminded at great cost, low, stable and predictable inflation and low variability in activity ... can breed complacency among financial market participants as risk taking adapts to the perceived new equilibrium."
To prevent such abuses in the future, Mr. Carney said central bankers should be allowed the freedom to use monetary policy to rein in financial markets as well as inflation. Currently, the Bank of Canada's agreement with the government restricts it to controlling inflation.
The observation and others at the Jackson Hole, Wyo. symposium - often called Davos for central bankers - suggests Mr. Carney has been thinking long and hard about what went wrong with financial markets in the summer of 2007.
The comments also suggest that Mr. Carney may be frustrated that while central banks did their part establishing an environment of stable and predictable price increases and economic growth, that did not help in averting the worst global recession since the Second World War.
On Friday, Federal Reserve chairman Ben Bernanke used his opportunity at the symposium to all but declare the recession in the U.S. at an end, saying the economy was stabilizing and that growth would return soon.
The text of Mr. Carney's speech did not directly talk about the economy - although he has already forecast a return to growth in Canada in this current third quarter.
Instead, he focused on exploring ways to prevent a repeat of the global economic disruption that began with a subprime mortgage crash in the United States.
The first line of defence, he said, is better regulation of financial markets.
But he added central banks should also take on responsibility to ensure financial markets don't get out of hand again, and not by simply issuing warnings.
They could use monetary policy - hiking interest rates - to cool off a financial markets bubble even if the measure causes the bank to miss its inflation target.
Essentially, "to generate price instability to prevent financial instability," he explained.
The recommendation is particularly relevant to Canada since the bank's current agreement with the federal government on maintaining a strict two per cent inflation target expires in about 16 months.
Mr. Carney's remarks suggest he favours a change to the bank's mandate that would permit it to implement "flexible" inflation targets after 2011. He said the bank is considering price-level targeting," which would allow it to miss the target one year if it made up for it in the future.
There are dangers to moving off a strict adherence to inflation targeting, Mr. Carney admits, not the least of which is loss of credibility if the bank gets it wrong.
"If the central bank were to lean for financial stability reasons and miss its inflation target as a consequence, its accountability could be diminished, its credibility reduced, and potentially, inflation expectations themselves could become unanchored," he admitted.
Then he asked whether the gain from achieving financial stability is worth the risk "of forfeited credibility." Given what has happened in the global economy the past year, Mr. Carney appears to conclude the answer is a qualified yes.