Knowing that monetary policy is "data-dependent" – as the phrase has it – leaves a lot of unanswered questions
In its interest-rate announcement on Wednesday, the Bank of Canada once again underlined that future changes in rates would be conditional on the data. Wednesday's news statement noted that the Governing Council will continue to focus on how sensitive the economy is to interest rates, how economic capacity evolves, and changes to wages and inflation.
That is fine as far as it goes, but for households and businesses trying to anticipate changes in the overnight rate, and therefore changes to market rates, knowing that monetary policy is "data-dependent" – as the phrase has it – leaves a lot of unanswered questions.
To clear up the uncertainty, the bank should consider publishing its projected path forward for interest rates.
Rightly, the bank combines economic models with discretion. As Governor Stephen Poloz noted in a September speech, "Models are indispensable for developing forecasts of inflation and the rest of the economy … Models provide us with a coherent starting point, but we need to apply real-world judgment before reaching a policy decision."
Some of this discretion comes from additional variables that are not directly in the bank's forecasting models, including the bank's own Business Outlook Surveys that contain more finely detailed information on how businesses see the future. One unanswered question for people trying to understand what the Bank of Canada will do is how people at the bank integrate the survey information into their forecasts. The private sector would gain from the BoC sharing how they see these relationships in order to better understand how the bank itself sees the future.
In Wednesday's announcement, the bank predicts that inflation will rise to 2 per cent by the second half of 2018, slightly later than predicted in July because a stronger Canadian dollar makes imported goods cheaper.
This prediction is based on the BoC's projection models, updated with the latest data. As an inflation-targeting central bank, the Bank of Canada chooses a path for its policy rate such that its models (tempered by judgment) predict a return of inflation to its target within a horizon of six to eight quarters. Publishing this path, and commenting on the factors that might make actual policy-rate settings different from what the path shows, would help people understand both the bank's forecast and how it might react to new information. Among other advantages, helping make the overnight rate more predictable in this fashion might enhance the bank's influence over aggregate demand, and thereby its ability to hit its inflation target.
One frequently stated objection to central bank policy rate forecasts is that uncertainty is so high that the information content of interest-rate forecasts is bound to be low. But the bank already forecasts the dates at which it projects inflation will return to target and when the output gap will close. The uncertainty around those is high as well, but those forecasts are still highly informative to Bank of Canada watchers.
The bank also reveals its forecasts for the long-run neutral rate of interest, where it will be once inflation is at target and the economy is at full employment. That is also highly uncertain – but knowing how the BoC is thinking about it also helps. Information about how and when it expects the policy rate to reach that level would help even more.
A second common objection is that the central bank's forecasts will be taken as promises, leading to a loss of credibility if it deviates. The bank could reduce this concern by publishing the conditional forecast relative to predicted changes to the long-run neutral rate. If its estimate of the long-run neutral rate were to fall, for example, a lowering of the overnight rate to maintain the same degree of monetary stimulus for the economy would make sense.
To bring this back to the real world, think about the implications for the average Canadian borrower. The concern we keep hearing about is what will happen to debtors if the bank further raises rates. Publishing a clear path for the overnight rate, and making clear how the path depends on economic developments, would lead borrowers to pay more attention to the probable future costs of taking out loans before they mortgage themselves to the hilt. Knowing that the Bank of Canada is data-dependent does not really help Canadians understand what it is likely to do. If the bank published a conditional path for its policy rate, Canadians would learn much more.
Steve Ambler is the David Dodge Scholar in Monetary Policy at the C.D. Howe Institute, and professor of economics at the school of management, University of Quebec at Montreal
Jeremy Kronick is senior policy analyst at the C.D. Howe Institute.
Published in the Globe and Mail