At the end of the last week, one of the Bank’s Deputy Governor spoke in Winnipeg on the benefits of well anchored inflation expectations and how inflation targeting has been a major contributor to anchoring these expectations.
He explained the issues and challenges ahead for the central bank as they start the process of renewing the inflation target agreement between the Bank and the Department of Finance for 2021. Very candidly, he spoke of the declining trend growth of developed economies and the dampening of cyclical recoveries that could be expected. While greater stimulus will be needed to offset these structural changes in the next downturn, he admitted that the amount of firepower that central banks have at their disposal is declining. Less space in G7 countries for borrowing to stimulate demand due to the overhang of debt resulting from the 2008 “fix” and a declining neutral rate will constrain the effectiveness of monetary policy in the next downturn. As a result, optimal macro policy would now demand more coordination of fiscal and monetary policy. Studies have shown that when interest rates are pinned to the bottom, countercyclical fiscal policy arising from the automatic stabilizers kicking in and discretionary spending, like infrastructure outlays are highly effective at supporting output. As a result, one of the things that the Bank wants to explore ahead of the renewal is looking into ex-ante mechanisms to co-ordinate fiscal and monetary policies to deliver better outcomes. Unlike what we see south of the border, fiscal and monetary policy should be pushing in the same direction.
With monetary policy potentially less powerful, as a citizen and asset holder, it would be reassuring to know that Parliament Hill and Wellington Street had a framework in place to ensure they would be leaning in the same direction post the next crisis in a timely manner. Unfortunately, the philosophical and practical hurdles, and their associated risks, attached to some sort of actionable agreement between the Bank and the government are extremely high.
From a historical perspective, if managing inflation is your goal, mixing politics with monetary policy has not worked well. Canada is a poster child in this area with the resignation of the Governor in 1961 when he set tight monetary policy to counter expansionary fiscal policy. For a long time, central banks, including the Bank of Canada (after the “Coyne Affair”), worked to get at arm’s length from their political masters to ensure rates were set by economic fundamentals, not set by the electoral calendar. There would seem to be some risk associated with tampering with this arm’s length arrangement.
It is probably also fair to ask if the commitment would be binding across governments. Politicians tend to do what is politically expedient. The commitment to the inflation target by the current government and the Bank cited in the speech as providing the genesis for an agreement to complementary monetary and fiscal policy in a crisis is only on a piece of paper that could be terminated by the stroke of a pen by the next government (may I introduce Jagmeet when he is confronted by “excessively” high rates that are necessary to quell inflation). Moreover, this commitment has the Bank accountable to parliament to achieve the inflation target regardless of fiscal policy dictated ultimately by the electorate. I doubt our elected representatives would want to be seen backing fiscal actions that are contrary to what their voters want; that were triggered by what many constituents view as an arbitrary target.
On the practical side, only in a text book could you come up with ex-ante mechanisms to coordinate policies. It is difficult enough for unelected officials to enact policy based on their outlook of what will happen. This is almost impossible for an elected official to risk his career on what may happen. Political momentum to enact fiscal stimulus beyond the stabilizers almost always happens after the sh** hits the fan (or they feel they are overtaxed, their military is still too small and they don’t have enough debt outstanding). Even if the triggers (whatever they may be) were correct in anticipating a time when coordinating policies was needed, the political process could easily derail the timing. Fiscal policy, apart from the automatic stabilizers, is not quick and nimble by design.
Given that monetary policy will not have the same amount of ammo going into the next downturn, it makes sense that the Bank pursues avenues to enhance overall macro policy. I am just not sure that relying on politicians to act in an appropriately sized and timely manner is the type of assurance the market would want to bet on. The best bet would be to structure your portfolio knowing the next time things go sour, the safety net below you is now much lower.
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