Despite the IMF's optimism, these are dangerous economic times<\/a><\/li>\n<\/ul>\nWhy no panic?<\/p>\n
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\u2019s 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 \u2014 the extent to which prices are influenced by the forces of supply and demand \u2014 appears to be milder than the headline number.<\/p>\n
The other reason there is no panic at the Bank of Canada is that the governor doesn\u2019t pretend that calibrating a $2-trillion economy is like playing darts.<\/p>\n
Poloz is aiming at the bull\u2019s eye, but he knows he may never hit it. The central bank\u2019s models aren\u2019t that precise. That\u2019s why the central bank gives itself wiggle room; the target often is communicated as 2 per cent, but that\u2019s 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.<\/p>\n
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\u2019t 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\u2019s unconvinced Canadian exporters are ready to compete in a world complicated by steady threats of tariffs and trade wars.<\/p>\n
So Poloz is comfortable tolerating inflation moderately faster than 2 per cent.<\/p>\n
\u201cSome people think it\u2019s more mechanical and that\u2019s fair; if inflation is going to be 2.3 you should be raising interest rates to make it two,\u201d he told a small roundtable of journalists in Washington on April 21. \u201cI want to go out of my way to help them appreciate that\u2019s not the way it works. That\u2019s why I mention the range in context of a forecast that clearly shows the overshoot.\u201d<\/p>\n
The \u201covershoot\u201d Poloz was talking about is in the central bank\u2019s 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.<\/p>\n
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.<\/p>\n
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\u2019s job would become harder. That\u2019s why he\u2019s 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.<\/p>\n
\u201cWhat I don\u2019t want is for people to be spending this entire year asking me what I\u2019m up to because inflation is above target,\u201d Poloz said in Washington.<\/p>\n
\u201cWe don\u2019t think it\u2019s fundamentally above target, so your expectations should still be 2 per cent because that\u2019s where we\u2019re headed back to. Every once in a while you need to remind people there\u2019s a range and that\u2019s OK. The policy allows for this. We\u2019re not violating our target.\u201d<\/p>\n
It\u2019s 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.<\/p>\n
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.<\/p>\n
\u201cThe whole thing about the range is you are supposed to have tolerance,\u201d he said. \u201cThat\u2019s why we picked that way back in the late \u201880s 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\u2019s equally true now\u2026the models haven\u2019t become tighter or more precise for us to claim otherwise.<\/p>\n
\u201cSo you aim at two, and it turns out to be 1.8 or 2.4 or something like this,\u201d Poloz said. \u201cThat\u2019s why we have a range.\u201d<\/p>\n
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