BoC’s moves to slow inflation are not inconsistent with pledge to target employment growth

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Last December, with notable fanfare, the Bank of Canada introduced a new wrinkle to its mandate with the federal government for conducting monetary policy.

In a joint news conference, Governor Tiff Macklem and Finance Minister Chrystia Freeland unveiled a new five-year agreement in which the central bank, while still focusing on its long-standing 2-per-cent inflation target, would also “actively seek the maximum sustainable level of employment.” It was considered a partial victory for critics who felt that in the past, the bank’s exclusive obsession with controlling inflation had resulted in raising interest rates before economic recoveries were truly complete, leaving some members of the labour market out in the cold.

Less than one year later, with the bank willingly pushing the economy to the brink of recession as it raises rates sharply, Mr. Macklem last week found himself explaining why he seems prepared to sacrifice jobs in order to hammer 7-per-cent inflation back down to 2 per cent. Isn’t this shirking the “maximum sustainable employment” commitment?

“What the ‘sustainable’ part means, really, is that it’s the maximum level of employment that the economy can sustain without creating inflationary pressures,” Mr. Macklem told Public Policy Forum (PPF) chief executive Edward Greenspon, in a podcast released by the think tank on Friday.

“When we look at a broad range of labour-market indicators, virtually all of them suggest that we’re operating above maximum sustainable employment – and that’s one of the factors that is driving prices up.”

It’s an important message – and, frankly, one that the bank’s critics would have already understood if they had been listening when the renewed mandate was announced last December. But as the mounting pressures on the economy fuel concerns that rising unemployment is around the corner, the bank has little choice but to publicly address what its employment mandate actually means.

Really, all the mandate change did was make explicit something that the Bank of Canada was already trying to do: allow employment to expand up to the point that it becomes an inflation problem. Labour cost pressures are fundamental to the inflation equation; when they are climbing because demand for workers exceeds supply (as it does now), that has long been a telltale signal to the bank that the economy is overheating and interest rates need to rise.

The inclusion of the maximum-sustainable-employment goal in last year’s mandate renewal also represented a compromise between the bank and the Liberal government. Ms. Freeland was interested in incorporating into the agreement some nod to the government’s principles of more inclusive economic growth. The bank was adamant that the 2-per-cent inflation target remain the guiding principle for monetary policy. In the end, they agreed to put in writing an approach to full employment that the bank already largely pursued, while maintaining the inflation target as paramount.

At the time, Mr. Macklem explained that the employment mandate might give the bank some leeway to be “patient” with rate increases when the economy appears to be approaching full capacity and the inflation rate is approaching target, to see if it could squeeze a bit more job growth without sparking inflation. The idea was that this sort of “probing” for additional job gains would only take place when inflation was still well contained. That is absolutely not the case today. Mr. Macklem was clear from the start that price stability would always take precedent.

Which is not to say that the current wave of rate increases is inconsistent with a “maximum sustained employment” goal, when you take the bank’s full meaning of the term into account. Indeed, as Mr. Macklem said in the PPF podcast, employment levels have measurably exceeded a sustainable maximum, and are thus contributing to the inflation problem. A key goal of the bank’s rate increases is to return the labour market to a healthy balance.

So, the bank can credibly argue that it hasn’t turned its back on its expanded mandate after all. Still, this was one of the worries among many observers when the mandate was unveiled last December: that the additional focus would muddy the bank’s message, make it less clear to the public exactly what it was doing and why. We’re now going through the first test of that – a big, important test, at that – and the bank must expend extra energy trying to explain the foundations of its policy making.

We can expect that further explanations are already in the bank’s communications pipeline. Mr. Macklem is scheduled to deliver a speech on Nov. 10 at a Public Policy Forum event in Toronto, on the topic of “the evolution of Canadian labour markets.”

The bank would be wise to get out in front of the “soaring rates are putting people out of work” narrative before its rate policies start weighing in a big way on employment. That would be a tough enough communications challenge at any time. As the bank’s rate hikes take an ever-bigger economic bite over the next several months, the “maximum sustainable employment question” will become one that Mr. Macklem will have to address more frequently.

That may not be a bad thing, and perhaps it’s something that central banks should be publicly addressing more often anyway. But it sure doesn’t make the Bank of Canada’s already complicated communications task any easier.