Bank of Canada Governor Mark Carney speaks at a Vancouver Board of Trade luncheon on June 15, 2011.DARRYL DYCK/The Globe and Mail
Well, now it's official -- sort of.
Probably the most important takeaway from Mark Carney's press conference Wednesday was his elaboration on the Bank of Canada's unmistakable, though never explicitly stated, view that the financial crisis and recession may have permanently altered the rules of monetary policy. In particular, the notion that the so-called neutral level for the benchmark rate is between 3 and 4 per cent, and that failing to reach it by the time excess capacity in the economy is chewed up, risks triggering rapid inflation.
Based on that thinking, it's easy to see why some economists (particularly in the academic community) have long argued that with a policy rate of 1 per cent and only so many rate decisions until mid-2012, when the bank says the gap between actual and potential economic output will be closed, Mr. Carney is flirting with falling dangerously behind the inflation curve.
But some economists have suspected, for at least a few months now, that just as the recoveries that follow financial crises take years longer than rebounds from your more garden-variety recessions, perhaps the new neutral isn't the same as the old neutral.
In a slight variation on this line of thinking, others argue that even if neutral is still, say, above 3 per cent but below the benchmark's average of 4 per cent from 1992-2007 -- a period that included what is nostalgically referred to as The Great Moderation -- the central bank doesn't necessarily need to rush to get there, whatever the models and theories say.
In his Monetary Policy Report Wednesday, Mr. Carney argued that when the economy is facing ``headwinds'' that could restrain growth over a long period -- like the strong loonie, a slower-than-usual U.S. recovery, the European debt crisis, et cetera -- ``the policy rate can deviate from its long-run level even if inflation is at target and output is at potential.''
During his press conference, he expanded on this view.
``You cannot mechanically assume that because the output gap on our projection, the output gap is closed in the middle of 2012, that the Bank's interest rate, target interest rate, will be back at neutral, however you define neutral,'' he said. ``If it were, then the output gap wouldn't close over that horizon, and inflation would not be back at target. And why is that? Well, there are considerable headwinds in the Canadian economy. They're largely coming from externally, but they include the dollar, the relative weakness in the United States, and the issues in Europe.''
Translation: Even though Mr. Carney sees the current benchmark rate of 1 per cent as ``exceptionally stimulative'' for an economy that is gaining strength and moving into expansion mode from recovery, moving to 3 or 4 per cent between now and mid-2012 would slow the recovery, if not throw it completely off course.
Some of the inflation hawks on the C.D. Howe Institute's shadow monetary council -- arguably the targets of Mr. Carney's ``headwinds'' analysis -- were already coming around to this idea. Of the five who (unsuccessfully) argued Mr. Carney should have raised borrowing costs on Tuesday, only one recommended that rates be higher than 2.5 per cent by July, 2012, and one even recommended a rate of 1.75 per cent -- precisely what most analysts believe it will be at that time.
Nonetheless, when I asked Mr. Carney at the press conference whether he had included that analysis as a direct response to those who have accused him of taking his eye off the ball in terms of inflation, he drove the point home further.
Without naming names, he suggested the analysis would ``serve a purpose'' for anyone who thinks monetary policy is ``simple,'' or should function ``according to some mechanical rule that dictates where monetary policy should be.''
``If we had been on autopilot during the recession, we would have driven this economy off a cliff because the mechanical rule would have kept rates far higher,'' Mr. Carney said. ``And if we were on autopilot right now, according to some mechanical rule, we would be ignoring the very real headwinds to this economy from the dollar, from the U.S., from Europe, and other risks that could present themselves, both positively and negatively. And so that's not what Canadians expect from the Bank of Canada. It's not what we do.''
Like habits, old theories die hard. Policy purists will still argue that the central bank's main job is to keep inflation advancing at 2 per cent a year, and with the core rate all but already there, Mr. Carney needs to get cracking soon.
But while I don't pretend to be an economist, or to come remotely close to understanding every element of their thinking, that explanation the other day from the chief economist at 234 Wellington Street sure made a lot of sense to me.