Philip Cross: The Bank of Canada has failed, not just Tiff McCallum

Canada has been going through its sharpest and longest inflationary recovery since 1983, almost 40 years ago.

Bank of Canada Governor Tiff McCallum. REUTERS / Blair Gable / File photo

The Bank of Canada’s misconceptions about the economy have led to a serious overshoot of the inflation target of 2%, plus or minus 1%. Not only overall inflation, conservatively measured by the CPI, rose 6.8 percent in April, but 70 percent of its components were above the bank’s three percent mark. Inflation is trending higher every month, as prices rose 10.2 percent in March and April. If Statcan finally includes the price of used cars in the CPI and the price of gas continues to go above $ 2 per liter.

The headline says inflation is the highest in three decades, but the 6.9 percent rate in January 1991 was actually a one-month spike due to the introduction of GST. In fact, almost 40 years ago, inflation in Canada has been going through its sharpest and longest recovery since 1983.

Bank of Canada Governor Tiff McCallum has defended his institution, saying “we have got more than just mistakes.” Nonsense. The only thing that the bank has done wrong is to control inflation.

McCullum should follow former Fed Chair William Martin by admitting he made a mistake. When Martin retired in 1970 with 4.7 percent inflation, he frankly admitted at his farewell luncheon: “I failed.” Such frankness and the bank’s commitment to do what it needs to do to bring inflation back to its two percent target as soon as possible will restore the bank’s credibility much faster than its own estimates, albeit about transparent, potential future interest rate movements. The bank’s target should be inflation, not interest rates.

Bank of Canada’s failure to control epidemic inflation is not the only recent failure

McClem is not alone in acknowledging that banks have stimulated the economy too much and underestimated the risk of inflation. Stephen Poloz insists that inflation is transient, a misconception he created as governor that helped spread inflation for which McClem is being blamed. Poloz argues that lower interest rates in 2020 and massive purchases of government bonds were necessary to prevent the epidemic of tailspin from turning into a 1930s-style depression. But it is controversial. The economy declined sharply and financial markets were uncertain in March and April 2020 when governments shut down large parts of the economy. However, it is not clear that after the initial shock of the onset of the epidemic, the problems of the economy have gone beyond lockdown and social distance, which were best addressed with targeted financial stimulus.

As the lockdown eased, the economy and financial markets recovered quickly, and most industries adapted to the epidemic in a creative combination of remote work and personal protective equipment. By the summer of 2020, it was clear that the economic losses were mainly for industries that needed face-to-face communication, which accounted for one-fourth of the economy. Targeted support programs will help these industries survive until vaccines become widely available. Instead, governments continue to pursue massive economic-wide fiscal and fiscal stimulus – as if they were tackling a deep-rooted crisis like 2008-09. The inevitable result of excessive stimulus was rising inflation.

The Bank of Canada’s failure to control inflation is not the only recent failure. Under Poloz, the bank has failed year after year to engineer its expected transition from debt-fuel and government spending to more sustainable gains in exports and investment. But both exports and investment required the cooperation of the business community, which was not forthcoming after Justin Trudeau’s 2015 election and his anti-growth agenda.

The Bank of Canada cannot be blamed for Trudeau’s weak economic policy, but it can be blamed for keeping interest rates low and encouraging a fiscal deficit in a futile effort to raise money. Over the years, the Bank for International Settlements, the central bank’s research clearinghouse, has warned the government that, at best, simple monetary policies will only have time to adopt policies that encourage business investment, reduce cross-barriers and increase long-term prospects. Provincial trade, and regulators cut red tape. But instead of increasing potential growth in this way, governments have relied on low interest rates to sustain growth for more than a decade.

Monetary policy should only be used to stabilize the economy against short-term unpredictable shocks, not fuel excessive demand over the years. Governor Poloz should have been more assertive in advancing the growth agenda and less cooperating in providing financial stimulus. Increasing potential growth over the past decade will help limit today’s supply constraints. Instead, the only option now is to reduce demand to meet the limited supply.

Central banks should not be easily left to their own devices when the epidemic begins and continues. The Bank of Canada estimates that even five per cent lower inflation costs আ 2,000 per Canadian in real income. In the short term, inflation carries the risk of both recession and financial market volatility because it raises interest rates to combat it, while in the long run it depresses the economy’s potential by increasing uncertainty.

Central bank independence means that Canadians relinquish democratic control of the Bank of Canada in exchange for a firm commitment to lower inflation and financial stability. It is reasonable to assume some responsibility when these goals are not achieved. The rise in inflation reflects the failure of an organization for a long time, not an isolated mistake of an individual.

Philip Cross is a senior fellow at the MacDonald-Laurier Institute.