Bank of Canada Governor Tiff Macklem takes part in a news conference in Ottawa, on April 13.BLAIR GABLE/Reuters
Tyler Meredith was an economic adviser to Prime Minister Justin Trudeau and two finance ministers.
On Wednesday the Bank of Canada will issue its next interest rate decision, which is widely expected to deliver another increase of somewhere between 0.5 and 0.75 percentage points.
While that much appears clear, there are two words I will be watching for in the bank’s communications: data dependence.
“Data dependence” is central-bank-speak to signal flexibility. It means the bank would move forward in light of economic indicators as they appear, not based on a predetermined path of rate hikes.
Flexibility is exactly what is needed today.
We find ourselves at a time when uncertainty and risk are high. In these situations, the worst thing we can do is follow a predetermined path and ignore signals as they emerge.
Although perhaps it was truer earlier this year, we are no longer in a situation that could be characterized as one of purely excess demand.
The Canadian economy has softened materially in recent months. More than 90,000 jobs have been lost since May, manufacturing activity has contracted for four straight months and retail sales are down.
Although year-over-year headline inflation remains uncomfortably high – 6.9 per cent last month – there has been a clear downshift in aggregate price pressures since the summer. In fact, thanks to a major deceleration of gas prices, the annualized inflation rate over the past three months is now close to 2.5 per cent.
To be sure, there are still some concerns – mostly notably, how inflation has broadened out from housing, food and energy. To the extent the biggest components are reversing their trends, we should expect to see a similar response in other categories over the coming months.
But as I have said before, higher inflation can reinforce inequality, which will lead to further economic problems. While we must not be complacent about fighting inflation, especially if it disrupts long-term price expectations, we must also not ignore the very real consequences that a strict and narrow adherence to fighting inflation has on growth and pocketbooks.
Despite what some critics say, we did not get here because of a mistake on the part of fiscal or monetary policy. While we can all see ways to improve policy with the benefit of hindsight, our recovery through the pandemic has been remarkable. And most of what has driven inflation across the developed world is associated with supply side shocks, found in the battlefields of Eastern Europe, Asian ports, and the lingering impact of COVID-19 on labour force participation.
Central bankers should have, with hindsight, begun raising rates earlier so that we could avoid the very challenging surge we are now experiencing. They have lost some credibility because of this mistake, but when they began to boost rates, the Bank of Canada did so in a determined fashion.
Having increased rates aggressively, we now have the virtue of being flexible. We can be. That is important, because the road ahead is much harder to foresee.
With inflation trending in the right direction, the next test for credibility will be whether the bank gives itself appropriate time and room to engineer the soft landing they claim to desire. If they don’t, whatever credibility rebuilt as a result of the most aggressive rate-boosting cycle in postwar history will evaporate if the cost of rebuilding the economic house is another blaze in a different form: a recession in which a substantial number of people lose their jobs.
There is ample evidence for the Bank of Canada to begin to slow down and potentially pause. They should heed it.
Canadians are already feeling some pain. Collectively, as consumers, we hold about $2.3-trillion in debt. As creditors eventually adjust for the increase in rates – some of which is happening in real time if, like most Canadians in the past two years, you went variable on your mortgage – Canadians will pay nearly $70-billion in extra costs to service the same debt. Per year.
For the average Canadian homeowner who took on a new mortgage of $370,000 this year, this rapid rise in rates, even before Wednesday’s decision, represents more than $11,000 in extra costs to the annual household budget. Few families have the shock absorbers to handle that kind of hit, let alone one that has played out in just a matter of months.
After all, economics is all about people. And behind the charts are people who go to work to earn a living, with income derived from someone else’s consumption that will in turn be used to buy things and pay debts.
It takes about a year for monetary policy decisions made today to work through the economy. We are at or near the point where it is time to enter the next phase of play, with an updated game plan: One which is more flexible and open to changes.