From the left: Federal Reserve Chairman Jerome Powell, Governor of the Bank of Canada Tiff Macklem, and Governor of the Bank of England Andrew Bailey attend the Jackson Hole Economic Symposium at Jackson Lake Lodge in near Moran, Wyo., on Aug. 23.Amber Baesler/The Associated Press
Jacqueline Best is a professor in the School of Political Studies at the University of Ottawa.
As inflation finally drops below 2 per cent all eyes are on the Bank of Canada’s next interest rate decision on Wednesday, with markets predicting a half-percentage drop. Meanwhile, the U.S. Federal Reserve finally started bringing rates down in September after raising them 11 times since March of 2022.
Does this mean that central bankers are the superheroes who have saved the day yet again? Or are they the supervillains that their critics make them out to be, responsible for the inflation that has driven the recent cost of living crisis?
Both of these narratives make the same basic assumption: that central banks have huge influence, for good or ill, over the state of the economy.
But do they really? As we enter a new phase in the monetary policy cycle, it’s worth taking a closer look at what central banks’ role is – and what it could be.
It’s not at all clear that central banks were responsible for driving inflation up in the first place. And there is growing evidence that central banks have not affected inflation’s ups and downs anywhere near as much they or their critics might like to claim.
A recent paper by French economist Olivier Blanchard and former Fed chair Ben Bernanke shows that most of the pressures driving postpandemic inflation were linked to supply chain blockages, energy price shocks, and energy-related food price changes – none of which can be directly addressed through interest rates. While exceptionally low interest rates and quantitative easing – where the government buys up bonds on the open market to push rates down further – may have lasted longer than was prudent, they were not the main cause of postpandemic inflation. The Bank of Canada is not the supervillain that its critics make it out to be.
More strikingly, it’s not clear that central banks’ policies played the primary role in taming pandemic-driven inflation. Most of the recent decrease in inflation can be attributed to the unwinding of temporary factors such as supply constraints and the shift in consumer demand from services to goods.
It’s true that inflationary expectations haven’t jumped the way that policymakers feared, but it’s not clear that this is because of the actions of central bankers (even if Fed Chairman Jerome Powell has been quick to take credit). Central banks are also not the superheroes of the economic story.
That doesn’t mean, of course, that the interest-rate hikes of the last two years didn’t have a major impact on our economy. Just ask anyone with a floating variable-rate mortgage, where payments have increased by an average of 49 per cent as of 2023, or those renewing in the next few years, who could also face a “payment shock,” as Canada’s banking regulatory, OSFI, noted in its last report.
If the Bank of Canada isn’t the superhero or supervillain, and yet its actions do significantly shape our lives, what should its role be?
The Bank of Canada can do more. Although central banks may not have saved the day this time, they do have tools they could use in this era of increasing uncertainty.
The Bank of Canada could take a more holistic approach to managing inflation by expanding its mandate to follow the U.S. Fed’s lead in formally taking employment into account, as Senator Diane Bellemare has proposed in Bill S-275. It could also take inspiration from the European Central Bank, which has developed innovative tools for making the financial system part of the solution in tackling climate change, instead of accelerating the crisis.
The Bank of Canada can also do less. Too often, politicians rely on central banks when the economy is in crisis, preferring to have unelected bankers make the tough decisions. We need to develop better co-ordination between fiscal and monetary policy and expand the economic toolkit so central banks aren’t our only go-to when we are confronted by a recession, a pandemic, a bout of unexpected inflation, or another financial crisis.
And the Bank of Canada can do better. Conservative Leader Pierre Poilievre’s threats to fire the Governor of the Bank of Canada were inflammatory and dangerous. The Bank of Canada is well respected at home and abroad. But that doesn’t mean that there’s no room for improvement. Central banks make decisions that affect millions of people: they need a governance structure that is open and accountable. The Bank of Canada is well behind its peer institutions in that regard, with interest rate decisions being made by internal consensus rather than through open deliberation.
We don’t need the Bank of Canada to be a superhero. We do need it to play a constructive, collaborative and innovative role in today’s economy.