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At Bank of Canada, a debate on revealing less

Bank of Canada governor Mark Carney


The greatest change over the Bank of Canada's 75 years is the institution's embrace of transparency. It's ironic, then, that the debate about the central bank's future is concentrated on ideas that would make policy more difficult to predict.

This is an important year in the central bank's history, and not only because Governor Mark Carney and his senior advisers face the delicate task of raising the benchmark interest rate from a record low of 0.25 per cent without crumpling the fragile recovery. To mark the bank's 75th anniversary, Mr. Carney is speaking today to university students all over the country via webcast.

It is crunch time for completing the research on whether there is a better way to achieve price stability than the current practice of targeting an annual inflation rate of about 2 per cent.

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The central bank is putting considerable effort into studying an intriguing, yet untested, technique called price-level targeting. Instead of targeting the rate of inflation, the central bank would attempt achieve a specified increase in inflation over a period of time.

While the method would theoretically give policy makers more flexibility, a major drawback is that even practitioners struggle to fully understand the concept, let alone explain it.

Mr. Carney hasn't signalled which way he's leaning on price-level targeting, but a serious disincentive is the risk that confusion might jeopardize the public's confidence in the Bank of Canada's ability to control inflation.

That's not to say that Mr. Carney is averse to making investors think a little harder about where interest rates are headed.

There is an emerging opinion that central banks contributed to the financial crisis by making their intentions for interest rates too predictable. The best example is the U.S. Federal Reserve, which, under former chairman Alan Greenspan, raised its benchmark interest rate in 17 quarter-point increments starting in June, 2004, and ending with the Fed funds rate at 5.25 per cent in June, 2006.

The worry - it must be said, in retrospect - is that too much transparency causes investors to become complacent.

Thinking they have the central bank's interest-rate path figured out, investors put less effort into assessing economic fundamentals. This creates a kind of groupthink that removes an important check on exuberant behaviour: skepticism.

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"How central banks communicate can influence the degree to which low, stable and predictable inflation fosters excess credit growth," Mr. Carney said in a speech at the annual gathering of international central bankers and monetary policy experts in Jackson Hole, Wyo., in August.

"It is important that markets understand how a central bank formulates policy, but that does not equate to perfect foresight. Differences in judgment and the fundamental uncertainties surrounding the economic outlook should mean occasional differences in view."

The speech has become a touchstone for the Bay Street economists and academics who earn a livelihood trying to understand how Mr. Carney thinks. While the commitment to keep annual inflation at about 2 per cent a year remains beyond doubt, some observers are preparing to be told a little less about how the Bank of Canada achieves that target.

"You don't want the complacency that comes about with so-well-telegraphed incremental moves in interest rates; I think [Mr. Carney]has that in the back of his mind somewhere," said Mark Chandler, a fixed income strategist at RBC Dominion Securities in Toronto. "It doesn't mean that he is all of sudden going to slam down a 100-basis-point move in the middle of a tenuous recovery, but I think it is part of the operating framework that he has." (A basis point is 1/100th of a percentage point.)

It's difficult to judge whether Mr. Carney is making the Bank of Canada more circumspect. He is contemplating making his intentions more difficult to read at the same time he raised transparency to another level.

In April, 2009, Mr. Carney dropped the benchmark rate to its current record low and pledged to keep it there until at least June, conditional on the outlook for inflation. The idea was to give consumers and investors, shaken by the global recession, some assurance that they could count on low borrowing rates well into the future.

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On the face of it, Mr. Carney's remarks in Jackson Hole appear to contradict his current policy. In fact, Mr. Carney is contemplating different levels of transparency for different times: when the economy is strong, it might be necessary to be a little less forthcoming in order to contain irrational exuberance; when the economy is facing crisis, the central bank needs to be crystal clear to avoid panic.

Any shift in communications strategy risks confusion. Sébastien Lavoie, assistant chief economist at Laurentian Bank of Canada, said the current approach works well, so "why change it if we are not 100-per-cent sure of greater long-term benefits associated with the pursuit of other goals?"

The answer appears to be that Mr. Carney doesn't want to repeat the mistakes of the financial crisis.

"There is a bit of a case to be made that policy became too transparent this decade," said Douglas Porter, assistant chief economist at BMO Nesbitt Burns in Toronto, adding that if the U.S. Fed had thrown some "surprises" at the market, some of the "extreme speculation" that led to the crisis might have been averted.



Moving forward: A new team

When Jean Boivin officially joins on April 1 as deputy governor, Mark Carney will be close to leading a Governing Council entirely chosen since he was named to replace David Dodge in October, 2007. As the Bank of Canada announced the addition of Mr. Boivin, it also said deputy governor Pierre Duguay, who joined the council in 2000 and central bank itself in 1973, will retire in July.

Aside from the turnover, there is something else unique about Mr. Carney's Governing Council: Most of its members are joining from outside the Bank of Canada.

What the Council does Created in 1994 at the behest of former governor Gordon Thiessen, the idea was to de-emphasize the role of the governor by introducing collective responsibility for monetary policy.

Governor: Mark Carney

Age: 44 Hometown: Fort Smith, NWT Background: international investment banker with Goldman Sachs; brief stint as deputy governor of the Bank of Canada; senior official at Finance Department.

Senior Deputy Governor: Tiff Macklem

(effective July 1) Age: 48 Hometown: Montreal Background: About two decades at the Bank of Canada; associate deputy minister of finance since 2007.

Deputy Governor: John Murray

Age: 61

Hometown: Toronto

Background: taught at University of British Columbia and University of North Carolina for a couple of years before joining the Bank of Canada in 1980.

Deputy Governor: Timothy Lane

Age: 55

Hometown: Ottawa Background: various teaching positions and the International Monetary Fund.

Deputy Governor: Jean Boivin (effective April 1)

Age: 37 Hometown: Chicoutimi, Que. Background: professor at HEC Montreal and special adviser at the Bank of Canada since August 2009.

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About the Author
Senior fellow at the Centre for International Governance Innovation

Kevin Carmichael is a senior fellow at the Centre for International Governance Innovation, based in Mumbai.Previously, he was Report on Business's correspondent in Washington. He has covered finance and economics for a decade, mostly as a reporter with Bloomberg News in Ottawa and Washington. A native of New Brunswick's Upper St. More

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