On Monday the Bank of Canada and Government of Canada finally announced the renewal of their agreement concerning the country’s monetary policy framework. The announcement reconfirmed their joint commitment to the two per cent inflation target within a band of one to three per cent. With the current agreement expiring at the end of the month, the down-to-the-wire announcement had led some pundits to expect a major surprise, and even in the follow-up coverage there are hints some believe this is what happened. We do not see it that way – which is good. The Bank’s mandate remains essentially unchanged from the last renewal, and from renewals all the way back to 1995 when the two per cent inflation target was first implemented. Extending this framework is what Canada needed now.
For the past several months, there have been rumblings that the government and the bank were considering major alternatives. Among the top contenders were a “dual mandate” (which would have the bank target both low inflation and some maximum employment level), a higher inflation target (which becomes particularly attractive when interest rates are low so the bank can reduce them without hitting zero), and average inflation targeting (in which the bank can let inflation run hot to make up for periods when it undershot the target). There was also chatter that the bank’s mandate might also include specific targets with respect to other economic issues facing the country — inequality and climate change chief among them.
Happily, none of these alternatives won the day and the status quo prevailed.
Start with the mandate itself. The new agreement makes no mention at all of higher inflation targets or targeting average inflation, which the U.S. Fed embarked on last year. Even with respect to adding maximum employment to the mandate, the governor’s opening statement made clear the bank will “continue to support maximum sustainable employment — that is, the highest level of employment we can expect to achieve without seeing inflationary pressures.” In other words, the bank already supports maximum employment but its focus on employment, while critical, is constrained by its inflation objective.
Nor did the announcement set a target for maximum sustainable employment, noting the difficulty of doing so, which has been exacerbated by the pandemic’s disruption of the labour market. The announcement says the bank “will consider a broad range of labour market indicators and will systematically report to Canadians on how labour market outcomes have factored into its monetary policy decisions.” But that has been part of the bank’s communication strategy since the beginning of the inflation-targeting regime, although the bank does now look at a broader range of labour market indicators than it used to. This sentence merely makes clear that flexible targeting of inflation already allows the bank to promote employment.
With respect to the other economic issues, the bank is well-equipped to deal with some but not others — in particular, specific targets for inequality and climate change. Instead, the announcement says the bank does have tools for modeling these other issues and will try to incorporate their potential impacts into its understanding of the Canadian economy. In our view, the bank should take into account a wide range of influences on the economy’s potential evolution — and already does.
There is some concern that the long, drawn-out renewal indicates that the government will be more involved in the bank’s affairs. We are not so sure. The bank is a crown corporation, so the government getting involved at renewal time is only reasonable. Renewal is normally a dull affair, but this one came against the backdrop of a pandemic, inflation at levels not seen in a long time, major new climate commitments by both governments and the financial sector, and more. And, despite all that, the status quo is largely intact.
Over the last five years the bank performed countless simulated horse races to investigate all the different monetary-policy-mandate alternatives. The public consultation leading up to this renewal was the most detailed in the history of the inflation-targeting regime. That the decision came late seems likely to have been mainly the result of how thorough-going the process was.
In the end, sticking with the status quo was the right decision. After three decades, the public understands the inflation-targeting framework well and, for the time being at least, inflation expectations are anchored at two per cent. The announcement confirms the bank’s commitment to low and stable inflation. With inflation running hot, that is a good thing.
Steve Ambler, a Professor of Economics at the Université du Québec à Montréal, is the David Dodge Chair in Monetary Policy at the C.D. Howe Institute, where Jeremy Kronick is Associate Director, Research.