The Bank of Canada should look beyond Wednesday’s rate decision and its policy of a conditional pause and commit to an unconditional end to the flurry of hikes.BLAIR GABLE/Reuters
Erin Weir is a consulting economist and a former member of Parliament.
At the end of 2021, the federal government added the goal of “maximum sustainable employment” to the Bank of Canada’s mandate. But over the past year, the central bank has undermined the job prospects of working, precariously employed and unemployed Canadians by hiking borrowing costs at every scheduled interest-rate announcement since March, 2022.
While employment remains close to a record high, it must continue growing rapidly just to keep up with Ottawa’s record immigration targets. Yet there is already evidence that the recent spree of interest-rate hikes has stalled economic growth, worsening the risk of a recession.
To properly reflect its broadened mandate, the Bank of Canada should look beyond Wednesday’s rate decision and definitively end the flurry of hikes that boosted the policy rate from 0.25 per cent a year ago to 4.5 per cent today.
The stated aim of higher interest rates is to limit inflation. They do so by reducing borrowing that finances spending and investment in everything from houses to factories to film shoots. Less demand for goods and services then moderates prices.
To be sure, inflation is a serious problem for Canadians. But higher interest rates are not the only or best solution. For example, they directly increase important components of inflation such as mortgage interest costs and rents that include mortgage costs.
Higher rates also do not work on their own to tame inflation.
Previous rounds of central-bank rate hikes dampened inflation in the mid-1970s, early 1980s and early 1990s only by also curtailing output and employment, leading to recessions. There’s a risk of the same thing happening this time around as well. Just last week, Statistics Canada identified interest-rate hikes over the past year as a cause of flat gross domestic product in the fourth quarter of 2022.
Since 1993, the Bank of Canada’s mandate has been to target a 2-per-cent inflation rate. In theory, the central bank was committed to raising interest rates to limit borrowing, spending, investment and ultimately employment as much as needed to pull inflation down. But in practice, rate hikes to constrain domestic demand during the 1990s were offset by expanding export demand at the time – a matter outside of the Bank of Canada’s control.
Years later, subsequent international events that reduced exports – the 2008 global financial crisis, the 2015 collapse of commodity prices, and the 2020 COVID outbreak – pushed inflation below 2 per cent. This drop allowed the Bank of Canada to rationalize cutting interest rates as a means of lifting inflation back up toward its target.
While inflation targeting proved benign or even positive when the figure was below 2 per cent – lower interest rates tend to boost the economy – such targeting when inflation is above 2 per cent carries a stark trade-off between squeezing it down and expanding employment.
The federal government wisely recognized this trade-off by adding employment to the central bank’s mandate in 2021. That moved the Bank of Canada a step closer to the U.S. Federal Reserve and the Reserve Banks of Australia and New Zealand, all of which have dual mandates to both control inflation and promote employment.
As today’s high inflation persists because of supply chain problems caused by COVID-19 restrictions and the Ukraine war, the Bank of Canada has been single-minded in hiking interest rates. However, its broadened mandate calls for a more balanced approach.
Governments can protect the vulnerable from rising prices by ensuring that public pensions, social assistance and minimum wages are not only indexed to inflation annually but increase promptly with new price data. Policy makers should enable more workers to bargain collectively and negotiate pay increases that better reflect inflation or explicit cost-of-living adjustments.
While advocates for such moves attract criticism for potentially exacerbating the situation, the truth is that the factors behind the current bout of inflation are not on the demand side – it is not workers making too much money that is driving up prices.
The inclusion of employment in the Bank of Canada’s mandate should give it pause. Instead of leaning on the central bank to combat inflation through further rate hikes, governments should do more to safeguard Canadians from inflation through prompt indexation and progressive labour laws.