Mike Moffatt is an assistant professor at Western University's Ivey Business School and chief economist at the Mowat Centre.
Should the federal government change the Bank of Canada's mandate? The question has received little attention but it's the most important economic policy decision Finance Minister Bill Morneau has to make this year, when the bank's operating mandate expires. I was grateful that economist Jim Stanford raised it in a recent op-ed for The Globe and Mail. I agree that the Finance Minister should consider changing the bank's 2-per-cent inflation rate mandate, and would recommend that he consider targeting the growth of nominal GDP, since it best fulfills three criteria for a central bank's mandate.
First, a central bank mandate should help moderate the business cycle, while addressing the macroeconomic challenges of the era. With baby boomers retiring en masse and zero-marginal-cost services becoming the norm, it's economic stagnation and avoiding ultralow nominal interest rates, not inflation, that should be our primary concerns today. We have entered a period of low or negative real (inflation-adjusted) interest rates, as an aging population increases the demand to hold debt, while the move from manufacturing to a service-based economy reduces the supply, since service firms typically have very modest financing requirements. The current 2-per-cent inflation target is indeed less than an ideal in such an environment.
Second, the target should be achievable. The Bank of Canada must be able to hit the target in the medium term with its primary policy instrument, the target for the overnight rate. Prof. Stanford suggests that additional policy instruments be considered. I agree, although I, too, find it unlikely. So we must ask whether the bank could meet its mandate using the overnight rate.
Finally, the target should be a single variable. This is far from a universal opinion, with Prof. Stanford suggesting that the bank could have an explicit mandate of simultaneously reducing unemployment and spurring growth. This is not unheard of ; the U.S. Federal Reserve has a dual mandate of maximizing employment and stabilizing prices. The problem with dual mandates is that they create uncertainty and tradeoffs between the two objectives. The "one tool, one target" approach has served the Bank of Canada well in communicating its objectives, and I see no reason to deviate.
There are not too many potential target policies for the Bank of Canada that meet all three objectives. While the current 2-per-cent target is a single variable, moderates the business cycle and is achievable, it does not address the issues of economic growth and ultra-low nominal interest rates. Raising the target rate, as Prof. Stanford suggests, does mitigate the nominal interest rate problem, but it still focuses on inflation rather than stagnation. As well, if the bank has trouble achieving a 2-per-cent inflation target, its ability to maintain a 3- or 4-per-cent target is an even more challenging goal.
A nominal-income-growth target, such as targeting the growth rate of nominal gross domestic product (NGDP), directly addresses the economic challenge of the era and is a single-variable target. So long as the target is high enough (I would suggest 5 per cent), ultra-low nominal interest rates are avoided as well. In theory, a nominal GDP growth target does a better job of moderating the business cycle, as it is more aggressive than an inflation target in bad economic times and less aggressive during economic booms.
The big issue is simply whether the Bank of Canada can hit a nominal GDP target. We need to keep in mind that there was a laundry list of economists who believed inflation-rate targeting would not work when it was adopted in 1991. That decision to target inflation was a gutsy one, as the Bank of Canada chose an innovative approach to the biggest economic issue of the era. It's time for the bank to repeat history, by adopting an NGDP target.