Bank of Canada’s new mandate comes with one wrinkle: politics

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The renewal of the Bank of Canada’s mandate agreement with the federal government grants the central bank a five-year licence to, largely, continue doing what it has already been doing.

Still, the pact, and the unusual process that led to it, add some new wrinkles to Canadian monetary policy that could take years to iron out. What is normally a dull, technical process has transformed into a political event – and that could have some hard-to-predict ramifications.

After years of research and consultations by the central bank, and months of back and forth with the Finance department, the two unveiled a deal on Monday that left the bank’s core mandate unchanged. It will continue to use monetary policy – chiefly, interest rates – to pursue an inflation target of 2 per cent, the midpoint of a 1-per-cent-to-3-per-cent range of tolerance.

At the same time, Finance Minister Chrystia Freeland and Bank of Canada governor Tiff Macklem took a modest but meaningful step to incorporate another priority – “maximum sustainable employment” – into the bank’s job description, while emphasizing that “the primary objective of monetary policy is to maintain low, stable inflation over time.”

Usually, these five-year mandate reviews are a snoozefest – conducted quietly, behind closed doors, and ending with a joint statement that more or less rubber-stamps the status quo. The inflation target hasn’t changed in three decades.

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This renewal was different. The bank made its own preparations much more thorough and public, and openly discussed options for altering its mandate. The coincidence of a once-in-a-generation inflation surge hitting at the moment the government was tasked with approving a new mandate turned the discussion into an increasingly hot political topic in the weeks leading up to the final agreement.

Monday’s announcement was not merely the usual release of a joint statement and some accompanying documents, but rather a joint media conference with the Finance Minister and governor – a rare event that spoke to the high profile that this renewal had reached. The end result – with its substantial focus on inclusive employment goals – has unmistakable echoes of the current government’s own priorities.

It’s well short of the “dual mandate” the Federal Reserve has long held, under which the U.S. central bank is formally tasked with pursuing both 2-per-cent inflation and “maximum employment,” with the two goals carrying essentially equal weight. It’s clear in the wording of this new agreement that when push comes to shove, the inflation target remains the Bank of Canada’s No. 1 priority.

That said, it does put the bank’s marching orders on a similar path, if not as far along it. There now is a second, clearly annunciated priority, placed above all others, save inflation.

One of the big attractions of inflation targeting, which was adopted not just by Canada but by many other major economies in the 1990s, has been that it has given central banks a single, clear and (it turned out) achievable goal for monetary policy. It worked – in a way that previous monetary-policy mandates, which targeted any of a number of sometimes-competing economic objectives, had failed.

On the other hand, critics have argued that the inflation focus has given central banks too narrow a view, that their singular pursuit has too often been to the detriment of other objectives that are, arguably, more important than price stability – for instance, whether there are enough jobs for everyone who wants one.

But over the years, the Bank of Canada found that the pursuit of the inflation target actually gave it enough flexibility to achieve other virtuous outcomes by keeping its eyes on the inflation prize. In practice, the inflation target isn’t just about maintaining low and stable prices to foster predictability and confidence among businesses and consumers (as the bank often says). Rather, the bank uses inflation as a proxy for gauging when the economy is approaching its full capacity – which includes the notion of full employment.

So, effectively, the Bank of Canada already pursues maximum sustainable employment when it applies interest rates – it just uses the associated rise in inflationary pressures, via wage inflation, as its handy tool to know when the economy is getting there. The new language in the five-year mandate will do little, if anything, to alter that approach.

Over the longer run, though, the entrenchment of employment commitments could complicate the bank’s inflation pursuit. Inflation and employment are, typically, opposing forces; the lower the unemployment rate sinks, the more inflation rises, because wages tend to increase more as the supply of available labour shrinks. Raising rates to fight rising inflation risks slowing the economy before you’ve squeezed maximum employment out of it. Under this new mandate, that may be a consideration that future central bankers feel obliged to give more weight.

But what may be of bigger concern is the degree to which politics wormed its way into this mandate renewal. One of the enduring strengths of Canadian monetary policy has been its well-protected independence from political interference. This process – while a once-in-a-half-decade event – has shown a new willingness for political leaders, both in the government and in opposition, to breach that wall.

Will a future government, five or 10 years from now, decide to reverse these changes and remove the employment pledges from the document? Will another government push to add its own priorities to the bank’s job – say, carbon reduction, or export expansion, or domestic industrial policy?

“It raises the risk that it becomes a political document,” said former Bank of Canada governor Stephen Poloz, who oversaw the early stages of the mandate review before he retired from the post in mid-2020.

“I think the attention being given to [the mandate renewal] is healthy. ... It’s too important for people to not care about it,” he said in an interview on Monday. “But ... it runs the risk that it becomes more political than I would like.”

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