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(Sean Kilpatrick/Sean Kilpatrick/The Canadian Press)
(Sean Kilpatrick/Sean Kilpatrick/The Canadian Press)

Economy Lab

Layton should stay clear of monetary policy Add to ...

In my recent post on the prospects of a possible NDP government, I came to the conclusion that not very much would change; their platform had none of the transformational elements that had been a feature of so many NDP campaigns in the past.

But if recent reports are correct, and if Jack Layton seriously thinks that it would be a good idea for a Prime Minister to instruct the Bank of Canada to keep interest rates low, then this benign assessment no longer holds. Such an intervention would be a serious mistake that would seriously endanger the recovery, and could generate another spiral of higher inflation and higher interest rates.

The first thing that would happen after such an order is that Governor Mark Carney would have no choice but to resign. This would be a serious shock to the financial system, and unless his successor could extract a promise that no further orders would be forthcoming, the Bank of Canada's credibility would simply disappear.

The Bank's mandate from the federal government is to keep inflation at around 2 per cent a year. Extremely low interest rates are appropriate during recessions, but when the economy returns to capacity -- as the Bank expects it will with the next 18 months -- then they become inflationary. By ordering the Bank to set aside its judgment and to let inflation increase beyond its target, the government would be in effect abandoning a policy that had provided the low and stable rates of inflation -- as well as the low and stable interest rates -- that we have seen over the past twenty years.

It took fifteen years and two recessions -- both of which were more severe than the one we just had -- to get inflation under control last time. That's not an experience we want to repeat.

As I was writing this, another story appeared, suggesting that Mr Layton was merely expressing an opinion about the appropriate path of interest rates, and not considering the possibility of ordering the Bank of Canada to keep interest rates low. Later, an e-mail from NDP headquarters assured that "New Democrats are committed to the independence of the Bank." I greet these clarifications with no small amount of relief.

Perhaps the most important lesson to be learned here is that Prime Ministers -- and those who would be credible candidates for becoming Prime Minister -- should be extremely circumspect when discussing monetary policy. Twenty years of hard-won credibility is not something to be tossed aside so lightly.

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