I missed the announcement, but after reading the Governor’s speech on the labour market, it appears that the Bank of Canada has decided to adopt the Federal Reserve’s mandate of full employment, stable prices and low long term rates. Remember when the Bank use to tell us it was only stable prices that mattered? It appears the market now has to deal with a Central Bank that is primarily focused on a mandate of maximizing labour force participation that I don’t remember anyone giving them, relegating inflation to somewhere in the background.
We are told that the economy is now in the sweet spot and by that I guess the Governor doesn’t mean that spot where the economy requires a ridiculous amount of monetary stimulus just to limp along at or under potential. No, he is referring to when the economy is pressing up against capacity constraints requiring firms to either invest and/or hire if they want to expand their output further. While a central bank totally focused on stable prices may start to calibrate their stimulus (ie. reduce) when this sweet spot is reached to get ahead of any budding price pressures, this speech suggested that monetary policy should continue to encourage demand to prompt further investment that can pull more people into the economy. In fact, we are told that they have an OBLIGATION to allow it given the significant benefits that would accrue from an economy operating at a higher equilibrium.
The speech takes us through a thought exercise where up to 500 k of additional workers could be drawn back into the labour market and employed, adding 1.5% to our potential output. All that has to happen is youth participation rates in the labour market go back to pre crisis levels, women’s participation rates rise to Quebec’s levels, indigenous people sign on and recent immigrants get more quickly integrated. Obviously that level of additional workers is not going to happen no matter how low rates go or how long they persist. Many of the hurdles to labour market participation do not fall in the realm of monetary policy. No, unfortunately, the hurdles exist as a result of political, educational, structural, cultural and generational factors. How high those hurdles are ultimately determines the amount of slack there is left in the labour market. My thought is that those hurdles are pretty high.
People that are not participating in the labour market have their reasons, not all of them economic. But if we believe in economics, the one thing that will bring some of them back is higher wages. If this is not accompanied by investment that allows productivity to keep pace, history shows us what the consequences will be for inflation. I find it odd that at the same time that the Bank is telling the market that investment is being negatively impacted by potential trade protectionist measures from Trump and his new buddy Larry that Governing Council is willing to risk that whatever level of investment does take place will be sufficient to raise productivity by enough to offset any wage inflation.
Look, I believe that it is very public policy minded of the Bank to want to focus on wringing every last drop out of the labour market. The harsh reality, however, is that is not the mandate they have been given. As a market participant, the risks change when a central bank decides that its policy power should be used to maximize employment inclusion and put stable prices at risk, versus one that sets policy to keep inflation near their target and have the risks falling on employment. To state the obvious, the interest rate path of a central bank that is content with its core inflation already near the target is a lot different than one that wants to test the bounds of labour participation. The downside risks are also very different. A steeper yield curve anyone?
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