The policy consensus that has guided economic decision-making for decades is being challenged like never before. In a new series, the Financial Post explores the opportunities and unknown costs of the Great Rethink.
It’s a source of some homegrown pride that Canada had a better 2008 crisis than the United States.
The U.S. entered the Great Recession with a lower jobless rate — five per cent in January, according to the Bureau of Labor Statistics, compared with 5.8 per cent in Canada, according to Statistics Canada’s comparable measure of unemployment — but fortunes reversed in June, as the global financial system started to tremble.
Canada then enjoyed an extended run of stronger employment that lasted until the end of 2014, when oil prices collapsed, sending the economy tumbling towards a recession. The U.S. unemployment rate has mostly been lower ever since.
But if you stare at those numbers long enough, you notice something else. Canada’s jobless rate — the one adjusted to match American statistical methods — was 4.8 per cent in autumn of 2008, an impressive number and one it wouldn’t return to for another nine years. The unemployment rate peaked at eight per cent, and then trundled lower for the better part of the decade before it found a new trough.
By comparison, the U.S. unemployment rate peaked at 10 per cent in the autumn of 2009 and hung around that level for a year before beginning a fairly sharp descent that didn’t stop until the coronavirus pandemic swept into North America. The country’s jobless rate was 3.5 per cent in February and tens of thousands of previously marginalized workers were finding jobs.
Canada’s labour market was strong, too, but not that strong. Why did the U.S., once it found its footing after the financial crisis, crush its unemployment rate while Canada merely trundled along?
There are multiple variables, but perhaps monetary policy — specifically, the Bank of Canada’s cherished inflation target — is partly to blame.
Canada’s central bank raised its benchmark interest rate to one per cent from 0.25 per cent between June and September in 2010, while the U.S. Federal Reserve kept borrowing costs pinned to the floor. Congress expects the Fed to achieve “maximum employment” along with price stability, while the Bank of Canada has been asked only to focus on inflation.
Both central banks did their jobs, so maybe the issue lies in the orders.
Canadian experts at the Bank of Canada and elsewhere maintain that price stability and low unemployment are linked: the former brings about the latter, always. But what if an obsession with inflation creates a conservative culture at a central bank, while an employment mandate forces policy-makers to take more risks? That could matter, especially since some economists think the relationship between inflation and employment has weakened.
Chrystia Freeland will be looking for stimulus levers to pull, and monetary policy could be a tempting one
It’s a question that new Finance Minister Chrystia Freeland might want to ask the Bank of Canada in the months ahead. Notwithstanding everything involved with the COVID-19 crisis, the most consequential decision she will make next year will be new five-year marching orders for the central bank governor.
That decision has tended to be a formality. There has been little compelling evidence for the Bank of Canada to deviate from the mandate first adopted in the early 1990s, when Prime Minister Brian Mulroney’s government signed off on a relatively novel plan for the central bank to use an inflation target — two per cent, the midpoint of a zone of tolerance of one per cent to three per cent — to guide interest rates.
Freeland’s choice won’t be so straightforward, especially since her thinking could be coloured by her government’s pledge this week to create one million jobs. She will be looking for stimulus levers to pull, and monetary policy could be a tempting one.
The Fed last month adjusted its approach to targeting inflation, adopting a policy regime that will likely see it leave interest rates at zero for much longer than it would have previously. The European Central Bank is also considering an update. Change is in the air.
“This is an excellent time to be considering many of these policy options and giving them some serious regard because we’ve seen such dramatic changes in the global economy and fiscal and monetary balance sheets,” Luba Petersen, an associate professor of economics at Simon Fraser University, said at a virtual conference hosted by McGill University’s Max Bell School of Public Policy this week.
A government that just set an ambitious hiring goal is bound to wonder whether the Bank of Canada can be more like the Fed
The Bank of Canada has done an excellent job of containing inflation, but perhaps it’s erred too often on the side of caution. There is reason to wonder, if not yet conclude, that Canada’s approach to monetary policy has become obsolete.
The Fed contributed to a disaster in 2008 by assuming Wall Street could be trusted to manage risk; more recently, it has demonstrated that it is possible to keep interest rates much lower, and for considerably longer, than most thought possible without stoking runaway inflation.
A government that just set for itself an ambitious hiring goal is bound to notice and wonder whether the Bank of Canada can be more like the Fed.
It can be, according to Douglas Laxton, a former Bank of Canada and International Monetary Fund economist who now is an adjunct professor at Portugal’s Nova School of Business and Economics: all it needs to do is adopt an employment objective to go along with its inflation target.
“Unemployment is the real problem,” Laxton said at the McGill conference.
Bank of Canada officials have sniffed at the Fed’s dual mandate over the years, calling it a political more than economic imperative. There’s a rule in economics that states central banks can only realistically achieve one target: the benchmark interest rate works more like a shotgun than a sniper’s rifle.
“Monetary policy has its limitations,” Carolyn Wilkins, the Bank of Canada’s senior deputy governor, said in an interview on Sept. 21. “At the end of the day, all it can do is affect the price level. How we do our job certainly affects the stability of the economy and that wonderful foundation that creates growth, but we can’t target particular sectors, or particular parts of the labour market. We can only create the conditions for that to happen.”
Still, Jerome Powell, the current Fed chair, has boasted that aggressive monetary policy helped lower the unemployment rates of Blacks, Latinos and other disadvantaged groups. New Zealand, the first country to adopt a formal inflation target, last year gave the central bank the additional objective of supporting “maximum sustainable employment.”
There could be a middle way. Two per cent is a target in Canada, not a ceiling; the Bank of Canada’s current mandate allows it to tolerate inflation as high as three per cent. It has room to manoeuvre.
Wilkins told a Bank of Canada conference last month that policy-makers could consider “probing” current theoretical constraints, in case the real world allows for hotter economic growth than mathematical models suggest is possible without losing a grip on prices.
“I would argue that a flexible inflation-targeting regime as we have also allows you to choose how quickly you want to return inflation back to target,” Wilkins said in the interview. “It’s perfectly possible within our current framework that we could take into account some uncertainty about where that sweet spot was in the labour market before you got too much inflation pressure, and by being more patient you could draw more people back into the labour force. We could incorporate that more explicitly in our mandate than we have right now.”
A dual mandate if necessary, but not necessarily a dual mandate. It could work.