David Dodge has been in the corridors of Canadian economic policy making and the battle against inflation for a half-century.
The former Bank of Canada governor is as good an authority as any to ask: Does today’s inflation problem look uncomfortably similar to the train wreck of the 1970s?
“It’s clearly different … But I don’t think it’s so very different,” he said in an interview last week. “We should not ignore the lessons that we learned from that experience.”
Both inflation episodes featured expansion of public spending that contributed to high demand. Both featured tightness in labour supply (though in the 1970s, widespread labour disputes were the main driver of that). And both were driven in a big way by massive surges in oil prices that pushed inflation pressures over the top.
The critical difference – so far, anyway – is that in the 1970s, consumers’ inflation expectations ran away from policy makers at central banks in Canada and elsewhere. Policy makers stood idle for far too long, letting inflation get entrenched in the public’s thinking – making the job of taming it increasingly difficult, and the damage increasingly severe.
“The issue for central banks is very much that they need to be careful not to let the expectations genie out of the bottle … which we didn’t do in the 1970s,” he said.
Mr. Dodge – who led the Bank of Canada from 2001 to 2008 – believes the central bank’s task is clear: get its policy interest rate much higher, and fast, to shut down rising inflation expectations before it’s too late.
“They need to get that up, and get that up quickly, to break expectations as quickly as possible – certainly by the summer.”
The Bank of Canada raised its key rate by 50 basis points (half a percentage point) in April, twice the size of the bank’s typical rate change – its first sign of increased urgency to get interest rates significantly higher in the face of Canada’s highest inflation in three decades. Mr. Dodge adds his considerable monetary-policy voice to the growing chorus of experts who believe the bank should get more aggressive still.
He argues that the bank should raise its rate by “50 points or even 75 points” in its early-June rate decision, “followed by another 50 or so” in the following decision in mid-July. That would rapidly get the rate into the 2-to-3-per-cent range that the central bank estimates is in “neutral” territory – where it neither stimulates nor inhibits economic activity. The current rate of 1 per cent is still quite stimulative to the economy – and, by extension, to inflation.
“That doesn’t really seem appropriate at a time when we have inflation running well above target,” he said.
Mr. Dodge had a front-row seat to the 1970s inflation policy failure. He was a senior official at the Anti-Inflation Board, the federal body that tried – in vain – to quell inflation by enforcing government-imposed wage and price controls. By the time the government shut down the board, and the central bank (along with those of other major industrialized countries) finally cracked down on inflation in the early 1980s, interest rates soared to 20 per cent and the economy was driven into a deep recession.
A decade later, Mr. Dodge was a top bureaucrat in the Finance department when it established the Bank of Canada’s inflation-targeting mandate and eliminated the federal deficit – two major policy achievements that helped finally snuff out inflation. He then spent seven years as head of the central bank, overseeing that inflation mandate.
One key difference between today and the 1970s – as current Bank of Canada Governor Tiff Macklem has pointed out – is that we now have a 30-year track record of central-bank monetary policy that has successfully defended a 2-per-cent inflation target. As a result, the bank has firmly established long-run inflation expectations around that target.
“It took the demonstration of bringing inflation down, it took time, for inflation expectations to get well-anchored on the target,” Mr. Macklem said. “That’s a huge asset that we have today. It’s also really important that we preserve that asset.”
But Mr. Dodge argues that the economic climate emerging from the pandemic poses a qualitatively different inflation problem than central banks and governments dealt with in the years prior. A variety of factors – from aging labour forces, to net-zero carbon transition, to geopolitical conflict, to a growing push to redraw supply chain and trade maps – point to supply constraints as the key element driving inflation, rather than the more traditional demand factors to which policy makers are accustomed.
“I think we have to be prepared to be thinking about a world that is more supply-constrained than we were used to in the first 19 years of this century,” he said.
That implies that central banks will be limited in just how much they can do to influence inflation; their primary tool, interest rates, is very much directed at pushing and pulling on demand. It’s obviously a big concern for Mr. Macklem and other central bank leaders, as they get aggressive with rate hikes – amid more than a little uncertainty about what impact those moves will have in this changing economic landscape.
“You can see it in the body language of both Tiff and [U.S. Fed chair] Jay Powell … they don’t want to move [rates] such that they kill everything and create a bigger problem. They are nervous. And reasonably so.”
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