The Bank of Canada’s interest rate hikes this year have “begun to work” to cool Canada’s overheated economy and slow inflation, the central bank’s governor said on Monday.
But with headline inflation still at about 7% today—five percentage points above the Bank’s target of 2%—Bank of Canada Governor Tiff Macklem said the BoC is prepared to continue hiking rates if needed.
“If high inflation sticks, much higher interest rates will be required to restore price stability, and the economy will have to slow even more sharply,” he told the Business Council of British Columbia in his final speech of the year.
“We are trying to balance the risks of over- and under-tightening monetary policy. If we raise rates too much, we could drive the economy into an unnecessarily painful recession and undershoot the inflation target,” he said. “If we don’t raise them enough, inflation will remain elevated, and households and business will come to expect persistently high inflation. With inflation running well above target, this is the greater risk.”
But so far, the 400 basis points of rate hikes delivered by the Bank this year are working to re-balance the economy, Macklem said. Domestic demand is slowing and the BoC is currently forecasting growth in GDP to be “close to zero” through the middle of 2023 as the economy continues to adjust to higher interest rates.
Macklem noted that it takes more than a full year for the full effect of monetary policy to work its way through the economy.
Inflation could be harder to control in the future
The BoC Governor also touched on how a number of disinflationary forces over the past two decades prior to 2020 have helped keep inflation low. These include:
- a “relatively stable” geopolitical landscape combined with a move towards free markets and global trade;
- technological advancements that lowered costs, in turn lifting global productivity;
- the entry of “vast” Chinese and Eastern European labour markets to the global trade system;
- and the rapid growth of global supply chains that linked the global economy and minimized costs.
“But these forces are now shifting,” Macklem said. “The failure to adequately share the benefits of growth has fuelled populism that is causing countries to turn inward. Support for globalization is stalling or even reversing, and productivity growth is trending down.”
On top of that, growth in the working-age population is slowing and businesses are finding it more challenging to hire workers, leading to rising wages.
“Over the long term, it seems likely that we won’t have the same disinflationary forces that we’ve had for the past 30 years,” Macklem added. “These potential developments could make it harder to bring inflation back to the 2% target and keep it there.”
If those inflationary forces prove to be stronger than expected, Macklem said inflation could consistently remain above the Bank’s forecasts. If those disinflationary forces return, however, inflation could come in below the target.
In both cases, Macklem said the Bank would “focus on achieving the 2% inflation target” by using its monetary policy framework—in other words, by raising or lowering interest rates.
“Assessing the impacts of shifting forces will be difficult in the moment, but we can be confident that our framework is designed for all seasons,” he said.
Feature image: Darryl Dyck/Bloomberg via Getty Images
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Last modified: December 13, 2022
