Heather Scoffield is the author of “The Flash Crash of 2008” and a fellow at the Macdonald-Laurier Institute in Ottawa.
I don’t consider myself an inflation hawk. But since 1988, when the Bank of Canada, responsible for managing the country’s monetary policy, began to charge interest on reserves, the pace of inflation has hardly budged. Why? I don’t know. The bank has gone out of its way, for more than 20 years, to describe the decline in inflationary pressures as a “temporary phenomenon.” So I’m not convinced there is a significant structural explanation. Even when the country was suffering through a recession, there was little evidence inflation was higher than it otherwise would have been because of weak demand or, again, bad policies.
This spring, however, the trend towards a prolonged pause in inflation picked up, and it seems to have lasted longer than some might have thought possible. Yes, growth has picked up, but that’s not the only story. Payroll employment is growing at nearly its long-term trend (10 years minus two), yet the country’s inflation rate has not eclipsed 2 per cent since the spring of 2017. What changed? Why, in a story that is all too often told in terms of “causes” that are peculiar to one government or another, the sudden and unexpected arrival of Canada’s current prime minister?
In Canada’s modern history, there are examples of governments having an impact on inflation for long periods. Déjà vu all over again, I guess. During the reign of Paul Martin, from the Spring of 2003 to the Fall of 2006, the prices of foodstuffs and household durable goods, both long-run inflationary indicators, fell sharply. Since his defeat, the prime minister in charge of inflation, Stephen Harper, has enjoyed few success stories. Inflation has continued to be low, but there is little evidence, or since the Bank of Canada switched to interest rate-based monetary policy, that the Bank has had more success in controlling price increases.
So what is the real issue here? It seems to me the biggest has been the bank’s failure to adapt to changes in global markets, now particularly connected to the increase in global trade. After the financial crisis of 2008-09, Canadian policy makers reacted quickly and prudently, finding ways to enhance their financial capacities. They imposed a new lending system, in which institutions were required to enhance their capital cushions and rein in credit growth. These measures worked in calming the nerves of financial markets, which bought many of Canada’s assets cheap. What was missing, however, were any credible measures to deal with trade.
Implementing the new lending regimes, when the global financial crisis showed the inadequacy of the system it was replacing, was a challenge. The government faced difficult questions about whether or not its new system could really accommodate increased credit flows, including bank loans that go to new banks or transfers between banks. And there were questions about whether or not the new system could handle foreign currency and commodities-related loans. Would the increased borrowing become economic or financial toxic? How could it be monitored? If things went wrong, who would pay for it? We don’t know that any policy success is possible these days, but maybe one would have been worthwhile.
I am not advocating that the Bank of Canada follow the Canadian model of 1980-90 and tighten lending standards. Inflation affects everyone in a given economy. The worst thing a nation can do is lock into monetary policy that saps its competitiveness and causes price increases to fall well below its long-run trend, taking the economy farther and farther away from normal.
But conditions today must also allow the Bank of Canada to respond more quickly to disruptions in markets and economic activity than it has in recent decades. It has to be prepared to do so. It has to be flexible enough to set policy when the situation warrants it. All of this can get lost in the elusiveness of parties who care too much about their own self-interest and too little about what’s good for Canada.