Bank of Canada to assess 2% inflation target in coming mandate review, Macklem says

The Bank of Canada will be assessing whether 2 per cent is the best target for inflation in a mandate review that begins next year, Governor Tiff Macklem said Monday.

 

Every five years, the central bank and the federal government agree to a set of goals for monetary policy, which the bank then pursues independently. Most important is the target for inflation, which the bank attempts to hit by adjusting interest rates.

 

In a speech to the Greater Vancouver Board of Trade, Mr. Macklem said the central bank will use the upcoming mandate renewal process, which starts next year and runs until 2026, to address several crucial questions.

 

“In a more volatile world, how do we identify and measure underlying inflation? Is 2 per cent still the best target for the future? What’s the interaction between housing affordability and monetary policy?” Mr. Macklem said.

 

The central bank has looked at whether 2 per cent is the right target several times before, including in its mandate renewals in 2011 and 2016. Each time it concluded the stability and flexibility provided by the 2-per-cent target outweighed any potential benefits of a lower or higher target.

Mr. Macklem noted that businesses are facing a range of cost pressures tied to fragmenting supply chains, climate change and other structural shifts to the economy, which could mean more upward pressure on prices. “Some people are saying, ‘Well, maybe we should just raise the inflation target.’ I will admit I’m not convinced, but I do think we have to have an open mind,” he said.

 

Since the last mandate review in 2021, the central bank has grappled with the biggest inflation surge in a generation. Annual Consumer Price Index inflation hit 8.1 per cent in the summer of 2022 before falling back to the 2-per-cent target by the second half of this year.

 

Mr. Macklem hailed the return of inflation to the bank’s target in his Vancouver speech, but warned of more economic shocks ahead amid rising protectionism, population aging, climate change and the spread of artificial intelligence.

 

“Trade protectionism and economic fragmentation are rising, and the appetite for global co-operation is waning,” Mr. Macklem said, nodding to U.S. president-elect Donald Trump’s threat to put 25-per-cent tariffs on all Canadian imports.

 

“The world looks more shock-prone. We hope some of the major uncertainties hanging over the world will be resolved. We can’t count on that – but we can prepare,” he said.

 

The speech follows the bank’s fifth consecutive interest-rate cut last Wednesday, which brought its benchmark policy rate to 3.25 per cent – the upper end of the bank’s estimate for the “neutral range,” which neither stimulates nor restrains the economy. Having cut interest rates rapidly since June, the bank will take “a more gradual approach to monetary policy,” Mr. Macklem said, reiterating the key message from last week’s rate decision.

 

The central bank learned a lot from the COVID-19 pandemic and the period of high inflation, which will inform the upcoming mandate renewal, Mr. Macklem said.

 

For one, monetary policy needs to focus more on the supply-side of the economy, he said. “The pandemic reminded us we cannot take that for granted. Supply disruptions can be sudden, severe and persistent, they can accumulate, and they are more inflationary when demand is strong,”

Central bankers also need a better understanding of business price-setting behaviour, which can change depending on the state of the economy, throwing economic models into confusion. The bank has already begun work on “next generation” economic models that will incorporate richer data and allow the bank to game out alternative economic scenarios, Mr. Macklem said.

 

He also pointed to lessons the bank learned from using “unconventional” monetary policy during the pandemic. This included quantitative easing – buying massive amounts of federal government bonds to suppress interest rates – and forward guidance, where the central bank promised to hold interest rates near zero for an extended period of time.

 

Both policies proved controversial and politically fraught as inflation started to surge in 2021.

 

“The crisis was developing rapidly, and a quick and bold response was critical. But we can see in retrospect that when we use extraordinary tools, we need to be clear about what we’re trying to achieve with those tools and under what conditions they’ll no longer be needed,” Mr. Macklem said.

 

“Perhaps most importantly, we need to remember that the actions we took were truly extraordinary. The bar to use exceptional tools has always been high in Canada – and it should remain high.”

 

 

 

 

This article was first reported by The Globe and Mail