No, the Bank of Canada’s mandate should not be reviewed
GUEST EXPERT. In a recent article published on the Radio-Canada website (1), Gérald Fillion, a brilliant journalist at the head of Zone Économie for several years, wonders about the mandate of the Bank of Canada (BoC)*.
Gérald Fillion insinuates that the mission of the central bank is too narrowly circumscribed to its inflation target set at 2%. He suggests that the achievement of a maximum sustainable level of employment should be given more consideration, without this objective being subordinated to that of price stability.
The dual mandate of the US Federal Reserve (Fed) is presented to us as an ideal model for establishing parity between the objectives of price stability and maximum sustainable employment. Moreover, the journalist argues that with an American-style mandate, the BoC could perhaps have slowed the pace of its monetary tightening by starting to raise its key rate well before March 2022.
It also echoes the political criticisms of the central bank, mainly voiced by Pierre Poilièvre of the Conservative Party and Jagmeet Singh of the NPD. The vehement criticisms of the Conservative leader are quickly discredited while those coming from the leader of the NDP are considered legitimate. Finally, he considers it relevant to question the work of the central bank and the need to plunge the economy into recession to bring down inflation.
A clear and legitimate mission
As specified in the most recent Joint Statement by the Government of Canada and the Bank of Canada regarding the renewal of the monetary policy framework, the Bank of Canada’s mandate is to keep inflation low and stable. Although achieving a maximum sustainable level of employment is desired, keeping inflation low and stable over time remains the central objective of the BoC’s monetary policy.
By its own admission, the Bank of Canada views the achievement of maximum sustainable employment as an objective that is difficult to measure and determined by fluctuating factors that are beyond its control (2). Achieving price stability is also what Canadians want from their central bank.
In 2020, during the consultations preceding the renewal of the BoC’s mandate, 53% of Canadians said they favored stable and predictable inflation to plan their economic life while only 20% preferred a maximum level of sustainable employment (3). Even that 60% of Canadians considered the employment-inflation dual mandate as something difficult to implement.
We have to admit that the vast majority of Canadians are right. Price stability and the achievement of a maximum sustainable level of employment are two essentially incompatible objectives. To reach a maximum sustainable level of employment, monetary policy must be excessively accommodating, which, in the medium or long term, contributes to fueling inflation, thus harming the bank’s price stability mandate. central. Moreover, the American experience precisely exposes the paradox between the two mandates.
The mirage of the American model
Officially introduced in 1978 by the American Congress, the double employment-inflation mandate imposed on the American Federal Reserve is far from being a model to be imitated. Since its introduction, history shows that the Fed has been unable to fulfill its two mandates simultaneously for a sustained period. Due to the antagonism of its two mandates, the US central bank constantly finds itself prioritizing them alternately. Once one is reached, the other becomes the priority, which makes the Fed’s monetary policy very ambivalent.
In December 2021, when inflation was at 7%, more than three times higher than its target of 2%, the Fed justified the maintenance of its accommodating monetary policy by the fact that the job market had not yet reached a maximum sustainable level. The unemployment rate was then 3.9%. Then, in March 2022, after reaching what it considered to be a maximum sustainable level of employment, the Fed gradually turned away from its inflation mandate that it had abandoned for months in favor of employment. .
Beginning in August 2022, the Fed unofficially jettisoned its full employment mandate to focus exclusively on inflation, then at its highest level in 40 years. Expressing serious concern over the high level of inflation in the economy, the US Federal Reserve acknowledged that its fight against inflation would jeopardize the job market and cause economic pain for US households.
Despite its dual mandate, the Fed did not intervene ahead of the inflationary surge. Doing so would have allowed it to slow the pace of its monetary tightening and avoid shaking the economy too much. In fact, it was precisely because of her dual mandate that she delayed her intervention. It preferred to prioritize employment to the detriment of inflation. Presumably, the US-style employment-inflation dual mandate is far from being a miraculous panacea to Canadian economic ills.
Inflation is a hard, highly addictive drug with a long and painful cure. Over the past sixty years, each of the inflationary periods whose peak was above 5% ended with the entry of the Canadian economy into recession. The slowdown in economic activity caused by the tightening of monetary conditions is the only remedy for the price increases that are currently weighing on Canadian households. And yes, this means that jobs will be lost.
Although the process is difficult, it is still necessary. Postponing weaning will only make it more difficult. Fortunately, once weaned from inflation, the economy will be able to flourish again, enjoying much more fertile ground.
Consequently, any criticism of the Bank of Canada’s monetary tightening is inappropriate. The central bank is just carrying out its recently renewed mandate as best it can while trying to retain what little credibility it has left after failing miserably to keep inflation at its 2% target.
By taking the liberty of harshly criticizing the Bank of Canada, both Pierre Poilièvre and Jagmeet Singh participate in eroding the independence of the central bank vis-à-vis politics. Moreover, in a recent interview granted to CTV, the leader of the NDP affirmed that there is no proof showing that the BoC is attacking the real source of inflation by raising its key rate. He goes further by claiming that the actions of the central bank will only push the Canadian economy unnecessarily into recession. These comments, both misleading and populist, only undermine the public’s confidence in the Canadian institution.
Finally, questioning the work of the central bank is fair. However, this is not the time for condemnation or revision of the BoC’s mandate. At this point, it is better to face reality. To bring down inflation, the Bank of Canada will have to plunge the economy into recession. As Tiff Macklem said at his most recent press conference, “there is no escape from getting inflation back on target”.
* The acronym BoC is preferred to BDC to avoid possible confusion with the Business Development Bank of Canada.
(2) https://www.bankofcanada.ca/wp-content/uploads/2021/12/Joint-statement-by-the-government-of-canada-and-the-bank-of-canada-concerning-the -renewal-of-the-monetary-policy-framework.pdf