Jim Stanford is the Harold Innis industry professor of economics at McMaster University.
The federal Liberals have successfully engineered an about-face in public attitudes toward fiscal policy. Rejecting the previous preoccupation with balanced budgets, Prime Minister Justin Trudeau’s government convinced most Canadians that deficits can make sense.
The government now has a similar opportunity to rework conventional wisdom in the other major area of macroeconomic management: monetary policy. The Bank of Canada’s five-year operating mandate expires at the end of this year, and the bank is currently discussing its future marching orders with Finance Minister Bill Morneau. An announcement of the bank’s next mandate will be made in coming months.
Since 1993, the bank has pursued an inflation target of 2 per cent (measured by consumer prices), with an allowable cushion of 1 per cent either way. By the narrow criteria of meeting that goal, the bank has a good track record: Inflation has stayed within the target band three-quarters of the time. However, a creeping negative bias is increasingly apparent, especially since the bank’s mandate was last renewed in 2011. Since then, the band was missed entirely in 11 months (always from below), and inflation has averaged just 1.39 per cent.
In a world where deflation is now a bigger risk than inflation, persistent weakness in consumer prices (coinciding with chronic weakness in overall demand and spending power) is worrisome. And the bigger problem has been the absence of a visible economic payoff from the inflation-targeting regime. The bank doesn’t target inflation for its own sake; it does so because it believes low and stable inflation is the “best contribution monetary policy can make” to economic progress: facilitating greater certainty, more investment and higher productivity.
In fact, however, the exact opposite has ensued. Gross domestic product growth per capita has slowed by one-third under inflation targeting, compared to the corresponding period before targeting. Under the bank’s current mandate, it’s been almost non-existent: 0.6 per cent a year and falling. Business investment has never been weaker.
It seems that stability in inflation means little to companies worried mostly about whether they can sell their output.
Targeting has certainly “anchored” inflation expectations around 2 per cent. In fact, even when the economy is weak, inflation tends to stick there. By a strict reading of targeting rules (whereby the bank focuses on inflation, and only inflation), that undermines the bank’s ability to counter economic downswings. Luckily, the bank has been interpreting its mandate more flexibly – cutting interest rates even when inflation alone doesn’t justify it. But it’s increasingly obvious that inflation targeting has become a polite fiction: It isn’t working the way it is supposed to, and central banks are actually motivated by other goals.
The bank is considering certain minor tweaks to its system, including a possible alternative measure of consumer prices. But it strongly favours a renewal of the basic target. Mr. Morneau should demand a bigger rethink. There are several options.
The target could be increased, to 4 per cent or 5 per cent. Many international and Canadian economists (including Pierre Fortin, former president of the Canadian Economics Association) have advocated this change. It would help avoid the problems that occur when interest rates fall to zero or below. Modest inflation also helps lubricate economic adjustment and erode the burden of debts.
Alternatively, the bank could be explicitly instructed to pursue other goals (namely, reducing unemployment and spurring growth) in addition to controlling inflation. More radically, inflation targeting could be abandoned altogether, replaced by a focus on job creation and sustainable growth (including using unconventional tools, such as asset purchases). That’s not likely, but the option should be considered.
Until recently, inflation targeting was trumpeted as a Holy Grail that solved all the major problems in macroeconomics. The chaotic underperformance of today’s economy proves this boast was hollow. We only reconsider the bank’s mandate every so often; this is the time for government to put everything on the table.
Contributed to The Globe and Mail
Published Monday, Aug. 08, 2016 5:00AM EDT
Last updated Monday, Aug. 08, 2016 5:08AM EDT