Bank of Canada Governor Stephen Poloz has overseen what appears to be a significant shift in thinking at the central bank, write Eugene Lang and Philip DeMont.
Bank of Canada Governor Stephen Poloz has overseen what appears to be a significant shift in thinking at the central bank, write Eugene Lang and Philip DeMont.
An important and surprising development has occurred in the dusty world of Canadian monetary policy. The essence of Canada’s monetary policy regime, which has been in place for a quarter century and is generally judged to be successful, seems quietly to be going the way of the Dodo.
In late January, Bank of Canada Governor Stephen Poloz unexpectedly cut the central bank’s benchmark interest rate by a quarter of a percentage point — not a big amount except that the so-called overnight rate stood at only 1 per cent and had not been touched in years.
In a speech at Western University, Poloz defended the rate cut by arguing that “the oil-price shock is an important setback in our progress toward full capacity, full employment and stable inflation because it is a net negative for economic growth.” The shock to which the governor referred is in reference to the fact that oil prices have tumbled almost 50 per cent in the past seven months, mainly in response to Saudi Arabia’s decision to maintain its output despite rising levels of production from U.S. shale fields.
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For Canada, a significant exporter of oil, the implications of lower oil prices are mixed. In the short run, consumers gain at the pump, but producers lose profit. Over time, the loss of oil industry revenue will mean weaker investment spending, job losses and eventually slower gross domestic product (GDP) growth, not to mention a big decline in tax revenues.
It was that logic that provided the backdrop for Poloz’s surprise rate cut last month. The central bank also revised downward its GDP growth forecast for Canada to 2.1 per cent for 2015, compared to almost 2.5 per cent earlier. The lower forecast was attributed to uncertainty surrounding oil prices.
The interest rate cut, the bank’s statement and the governor’s comments are clear signs that the central bank is concerned Canada’s economy will take a major hit from a distressed oil sector, an industry which accounts for only 3 per cent of Canada’s economic output.
But there is more at play than that. This episode signals a departure from 25 years in which monetary policy has been conducted on the basis of controlling inflation, rather than stimulating economic growth (with the exception of the 2008-09 global and financial crisis in which almost all central banks moved to a co-ordinated, extraordinary monetary stimulus posture for a period of time, in part to forestall the risk of deflation).
Since 1991, monetary policy in Canada has been aimed at achieving a single goal — keeping inflation low and stable. Over the past two decades, following the high inflation of the 1970s and 1980s, a belief took hold in Canadian central banking circles and in the federal government that monetary policy was at its best and would contribute most to Canada’s economic health if it focused on the goal of maintaining low and stable inflation with an inflation target of between 1 and 3 per cent. Four successive governments — from the Mulroney PCs, to the Chrétien/Martin Liberals to the Harper Conservatives — have agreed formally with the Bank of Canada every five years to this approach to monetary policy.
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Now, it would seem, times have changed. The central bank’s most recent rate cut is a sign that Poloz and his team now have other goals for monetary policy beyond meeting the inflation target, such as bringing “the Canadian economy back to full capacity,” an admission that monetary policy is now being conducted to achieve a particular level of economic growth.
Why the change in policy? We don’t really know. The Bank of Canada has not acknowledged that this marks a real change. But we can guess. Perhaps the prevailing economic wisdom has shifted as a result of the 2008 recession and the extraordinary international monetary and fiscal stimulus it induced, and has produced a realization that central banks can and should aim to stimulate economies when they are hit by shocks like a big drop in oil prices.
Irrespective of the reasons, the central bank’s new approach to monetary policy is not necessarily a bad development for Canada. That is something economists will debate for years.
It is, however, more than a little ironic that the Bank of Canada — that bastion of economic conservatism — has now basically adopted a posture that Canada’s left (and in particular the federal NDP) advocated for many years. Namely, that monetary policy should not be focused solely on controlling inflation, but must have an eye toward achieving full employment and stimulating growth.
Maybe the NDP’s economic thinking, which has been derided for years by economists, federal governments and the business community, is finally becoming mainstream after all.
Eugene Lang is BMO Visiting Fellow, Glendon School of Public and International Affairs, Glendon College, York University. Philip DeMont is a freelance journalist and economist.
