While inflation pressure heats up, Stephen Poloz comfortable with keeping his powder dry
Bank of Canada Governor Stephen Poloz’s life would be easier if his core public was better with nuance.
Alas, he performs for a crowd of economists and traders that sees the world through mathematical equations. Those calculations produce precise numbers, and those numbers are supposed to tell us something about the future. And right now, some of those numbers seem to show that Poloz is about to lose his grip on inflation.
On April 20, Statistics Canada reported that the Consumer Price Index was 2.3 per cent higher in March than a year earlier, the biggest increase in four years. That’s faster than the central bank’s target of 2 per cent, suggesting policy makers should be raising interest rates to cool things down. And yet only two days earlier, Poloz and his lieutenants had decided to leave their benchmark unchanged at a very low setting of 1.25 per cent.
Why no panic?
A couple of reasons. One is that inflation likely is being influenced by temporary factors such as higher oil prices and the increase in Ontario’s minimum wage. These things are pushing the CPI higher than its level a year ago, but by this time in 2019, those effects could be gone. The trend rate of inflation — the extent to which prices are influenced by the forces of supply and demand — appears to be milder than the headline number.
The other reason there is no panic at the Bank of Canada is that the governor doesn’t pretend that calibrating a $2-trillion economy is like playing darts.
Poloz is aiming at the bull’s eye, but he knows he may never hit it. The central bank’s models aren’t that precise. That’s why the central bank gives itself wiggle room; the target often is communicated as 2 per cent, but that’s for the sake of simplicity. The official goal is to keep inflation at the midpoint of a range that starts at 1 per cent and extends to 3 per cent.
That range was created for moments when the economic backdrop gets complicated. This is one of those times. The Bank of Canada noted that inflation was weaker than the target in 2017, suggesting the economy probably isn’t in danger of suddenly overheating months later. Elevated levels of long-term unemployment and youth joblessness imply there still is slack in the economy. He’s unconvinced Canadian exporters are ready to compete in a world complicated by steady threats of tariffs and trade wars.
So Poloz is comfortable tolerating inflation moderately faster than 2 per cent.
“Some people think it’s more mechanical and that’s fair; if inflation is going to be 2.3 you should be raising interest rates to make it two,” he told a small roundtable of journalists in Washington on April 21. “I want to go out of my way to help them appreciate that’s not the way it works. That’s why I mention the range in context of a forecast that clearly shows the overshoot.”
The “overshoot” Poloz was talking about is in the central bank’s latest quarterly report on the economy. The central bank predicted the CPI will increase 2.3 per cent this year, compared to its previous estimate of 2 per cent. Policy makers see inflation sticking at 2.1 per cent in 2019 and 2020.
An outlook like that would have caused other economists to raise interest rates last week. There is a school of thought that if inflation is at target you already are too late because changes in interest rates take months to influence the behaviour of buyers and sellers.
Central bankers also must strive to anchor expectations of where prices are headed. If the public starts to think inflation is headed to 3 per cent, Poloz’s job would become harder. That’s why he’s sensitive to the suggestion that setting monetary policy is easy. He needs to win the debate; if the Bank of Canada loses credibility, expectations could become unmoored and it would have to raise interest rates faster to compensate.
“What I don’t want is for people to be spending this entire year asking me what I’m up to because inflation is above target,” Poloz said in Washington.
“We don’t think it’s fundamentally above target, so your expectations should still be 2 per cent because that’s where we’re headed back to. Every once in a while you need to remind people there’s a range and that’s OK. The policy allows for this. We’re not violating our target.”
It’s important to keep in mind that the Bank of Canada has stated explicitly that it plans to raise interest rates. Most economists see a quarter-point increase in either May or June. There is less agreement on whether there will be another one before the end of the year.
Those who feel they need to know the path for interest rates with more precision will have to get used to some fuzziness from the central bank. Poloz simply refuses to pretend the future can be seen clearly in an economic model.
“The whole thing about the range is you are supposed to have tolerance,” he said. “That’s why we picked that way back in the late ‘80s because our models told us that on a six-to-eight quarter horizon, plus or minus one percentage point was the best we could hope for in terms of control. I think that’s equally true now…the models haven’t become tighter or more precise for us to claim otherwise.
“So you aim at two, and it turns out to be 1.8 or 2.4 or something like this,” Poloz said. “That’s why we have a range.”
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