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Description
Canada's macroeconomic situation has not looked better since the mid-1960s, but this very fact should prompt a little reflection. Low inflation and economic stability seemed to be well established then as well, but soon after, they began to come apart, and a full quarter-century passed before they were restored. What happened once can happen again, because satisfactory macroeconomic performance, if it is to be sustained, requires the support of a coherent monetary order. Just because Canada's current inflation-control program has coped well with the stresses of the recent past does not mean that it is proof against those that it has yet to encounter, or that it reflects the current state of the art in such arrangements. Even, or perhaps particularly, in what seem to be good times, a little attention to these matters can go a long way towards enhancing the chances that those times will persist.
The Importance of Public Support for Monetary Stability
William Robson (2007) recounts how Canada's post-war monetary order, while always fragile, collapsed in the 1970s and 80s. He suggests that much of the credit for the country's improved economic performance over the last 15 years or so should go to the restoration of coherence in monetary policy since the early 1990s. Specifically, he reminds his readers that a 2 percent inflation target, agreed on by the Bank of Canada and successive ministers of finance, has been pursued by the Bank without further political interference, and has also been supported by responsible fiscal policy. He argues that this policy regime has provided a foundation for steady employment growth; reasonably peaceful labour relations; a slow expansion of incomes that has nevertheless modestly outpaced increases in the cost of living; as well as predictable and manageable interest rates on mortgages and consumer loans. Only a large exchange rate swing has given any cause for concern.
The Dangers of Success
Monetary policy in Canada is nevertheless not a solved problem, because a few warning signs have appeared recently that public understanding and support for the current monetary order might be dissipating. Last year's renewal of the inflation-control program until 2011, for example, attracted little attention. Of course, the very fact that the population at large no longer worries continually about inflation as it conducts its day-by-day business is a sign of inflation targeting's success, but such success has its dangers. Policy proposals capable of undermining monetary stability can easily appear attractive to an electorate that has grown used to stability, and lost sight of the need to maintain the policy regime that has delivered it. Witness, for example, the recent popularity of arguments that the Bank of Canada should hold interest rates down in order to protect exporters of manufactured products from an appreciating currency.
In any event, the inflation-targeting regime, introduced in 1991, has never been subjected to a comprehensive review, so the Bank of Canada's (2006) promise to undertake one between now and 2011, and to encourage public participation in it, is extremely welcome. This announcement, long enough in coming to warrant a "better late than never" response, provides the raison d'etre for a new initiative on Canadian monetary policy from the C.D. Howe Institute.
Issues to be Discussed
The Bank of Canada's announcement proposes a wide-ranging agenda, dealing with technical issues concerning the execution of policy, as well as with broader matters of principle. Many of the former, important though they are, can be addressed within the terms of the agreement currently in place between the Bank and the minister of finance. (1) Not so the latter, however, and this Commentary addresses two of the more pressing matters at hand. First, whether the target rate of inflation should be lowered from 2 percent; and second, whether policymakers should continue to treat past inflation performance, when it has under-or overshot their target, as a bygone in their deliberations on future policy, or should rather attempt to cancel out its effects on price levels.
These two issues will be discussed here as a package because, though it would be possible to make either change without the other, their joint implementation would in effect shift Canada's monetary order from a low inflation to a price-level stability goal, a prospect that requires early analysis and debate if it really is in the cards for 2011.
To begin with, smooth implementation of such a change will require the ground to be prepared well in advance, but even more important at the current juncture, the pros and cons have not yet received the systematic examination and public discussion they require. That is why this Commentary identifies issues that need further attention rather than making firm recommendations.
Specifically, the following questions will be raised below: whether the achievement and maintenance of price stability would bring gains in economic efficiency relative to the status quo; whether moving to it would entail significant costs; whether even our current low inflation rate has effects on the distribution of income and wealth that would be worth eliminating; whether developments abroad, and particularly the US, might in any way narrow the scope of Canada's monetary policy choices; and whether, finally, there is any prospect of political support for monetary change.
As we shall see, the experience of the last 15 years has already generated answers to some of these questions that are different from those we might have expected in the early 1990s, even if some remain tentative, and not all point in the same direction. Thus, low inflation proved more easily sustainable than was widely believed when it became a policy target, and its achievement has done much to promote improved economic performance. Even so, at least in the light of experience to date, it is hard to argue that further efficiency gains to be had from a move to price stability would be large enough to warrant incurring the costs of achieving it. But distributional considerations--who loses and who gains from inflation--could conceivably tip the balance in its favour. Along with international considerations, they might also emerge as sources of political support.
The View From 1991
Monetary... |
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