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David Jones: Evidence and history suggest we’ll be worse off if Bank of Canada is pressured to moderate rates
Monetary policy in Canada is rapidly turning into “monetary politics.”
High interest rates have solicited recent outbursts of concern from several premiers, with Ontario’s Doug Ford highlighting the “crushing pressure” on many families and businesses in a public letter to Bank of Canada governor Tiff Macklem in October.
Even the minister of finance, Chrystia Freeland, publicly “welcomed” an interest rate hold in September. Though subtle, the language was a tacit seal of approval, and a hint of federal sentiments had the outcome been different.
Political and social disquiet is understandable. Voters face mounting affordability concerns from higher mortgage costs and day-to-day prices. The rise in rates is the steepest in 40 years.
The premiers’ letters, arguably, make for good politics: There is little to lose, and central bankers are an easy target. And besides, the premiers have no formal sway over monetary policy, anyway, so why not try to score some points with voters?
Safe to say, Macklem didn’t see their meddling as entirely benign. A governor’s bread-and-butter is to explain why low inflation remains the priority in the face of wider risks to the economy and/or society. But Macklem was sufficiently roused to publicly push back, stating it would be “unfortunate” if political interference were to undermine the bank’s independence.
At what point does political posturing around monetary policy become a genuine risk?
The central bank prioritizes low, stable inflation. This financial fixation might seem socially tone-deaf at times, but inflation creates social and economic damage through household affordability challenges and less transparent prices.
High, long-lasting inflation is painful to correct. In the 1980s, inflation soared to 12 per cent, the bank increased rates to 21 per cent, and Canada experienced a severe recession. As William Martin, former chair of the United States Federal Reserve, once put it: “Inflation is a thief in the night and if we don’t act promptly and decisively we will always be behind.”
Governments, too, have an inflationary bias. Despite good intentions, in the short-term they can’t help but lean towards higher employment or, more cynically, to prime the economy with additional fiscal spending. Outsourcing monetary policy to an operationally independent central bank seeks to solve this problem by creating a credible commitment to low, stable inflation. If independence is undermined, so is central bank credibility, and inflation can become a self-fulfilling prophecy.
While the premiers, in their own defence, might point to monetary policy being as much art as science, the downsides of substantial political meddling in central bank affairs are hard to ignore.
Turkey provides an extreme example of the damage populism can do. President Recep Tayyip Erdogan has fired four bank governors since 2019, sending inflation soaring as high as 80 per cent in 2022. Following a policy U-turn, interest rates have risen to 35 per cent and inflation forecasts have halved. Turkey’s economic transition will be painful, but with food inflation recently breaching 60 per cent, the status quo is even worse.
The U.S. also knows a thing or two about undermining central bank independence. In the 1940s, the U.S. Treasury directed the U.S. Federal Reserve toward low interest rates, sparking a bout of inflation. Monetary autonomy was promptly returned to the Federal Reserve in the 1950s.
Turkey is an extreme example and Canada’s institutions are better-placed to deal with monetary politics. Nonetheless, risks exist.
Though inflation fell to 3.1 per cent in October, it could remain sticky, leaving the bank with a dilemma over whether to further increase rates. War, higher energy prices and fiscal expansion could also renew upward price pressures.
Politicians could continue their letter writing and grandstanding, increasing public opposition to strict inflation-targeting. More misleading rhetoric — that the central bank “caused inflation” — could stoke populist rumblings. Further comments from the minister of finance could be unhelpful given her formal powers to provide a directive to the bank.
Ultimately, the recent ministerial representations are manageable. Monetary politics even arguably has a place, with ministers ensuring that central banks “feel” the societal impacts of monetary policy.
But the recent exchanges serve a warning. Evidence and history suggest that Canadians will be worse off if the bank is pressured to moderate rates. Interest rates are blunt enough without having to contend with political interference.
Practically speaking, if premiers are looking to start a running public commentary on the central bank’s decisions, they should direct concerns to the federal government, which sets the mandate for the bank.
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Finally, the bank should look to help itself: The next monetary policy framework should be future-proofed by considering risks related to both a high-interest rate and low-interest rate environment, given the current framework solely discusses the latter.
David Jones is a policy analyst and economist. He is a fellow at the Canadian Centre for Health Economics and is studying public policy at the Munk School of Global Affairs and Public Policy, University of Toronto.
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