Tiff Macklem’s Bank of Canada is toying with letting the economy run hotter than would have been thought safe only a few years ago, re-enforcing the likelihood that interest rates will remain extremely low for at least another couple of years.
Macklem, who took over as governor in June, observed on Feb. 23 that the unemployment rate had been unusually low for an extended period of time before the pandemic, and yet inflation never took off.
It could have been a fluke. But in case it wasn’t, Macklem indicated that he and his deputies on the Governing Council are agreed that they should probe the limits of their previous understanding of the relationship between employment and inflation. The pre-pandemic experience suggests the central bank needn’t fear inflation quite as much as it has in the past, which would allow policy-makers a freer hand to stoke economic growth.
“Based on past economic cycles, we would have expected inflationary pressure to begin to rise,” Macklem said in a virtual speech hosted by the Calgary and Edmonton chambers of commerce. “But inflation wasn’t threatening to take off. As the pandemic recedes and the recovery continues, we will keep that experience in mind.”
The unemployment rate dropped below six per cent at the end of 2017 and averaged 5.8 per cent until the governments shut down most of the economy in March 2020 to fight COVID-19.
That’s supposed to be full employment, according to the Bank of Canada’s understanding of how the economy works. That is, when the jobless rate drops that low, economists at the central bank have long assumed that everyone who wants a job would have one, and therefore growth would be such that inflationary pressures start to build.
But inflation was never a major concern. The Consumer Price Index (CPI) averaged annual growth rates of about two per cent throughout that entire period, which is what the Bank of Canada is obligated to achieve. The relationship between the unemployment rate and prices appears to have changed.
Macklem’s latest remarks suggest that policy-makers won’t worry too much about inflation until the jobless rate returns to those pre-pandemic levels, which were the lowest on records that date to the mid-1970s. We’re a long way from that point now, as the unemployment rate was 9.4 per cent January, according to Statistics Canada’s latest reading.
“We can expect a long adjustment process and a protracted recovery,” said Macklem. “The economy will need support for quite some time, and the bank will continue to do its part.”
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