David Dodge has been in the corridors of Canadian economic policy making and the battle against inflation for half a century.
The former Governor of the Bank of Canada is as good an authority as any that asks: Does today’s inflation problem look alarmingly similar to a 1970s train wreck?
“It is clearly different… but I don’t think that is the case very Different,” he said in an interview last week. “We should not ignore the lessons we learned from that experience.”
Both periods of inflation were characterized by expansion of public spending which contributed to higher demand. Both showed a tight supply of labor (although in the 1970s, widespread labor disputes were the main driver for this). Both have been largely driven by massive oil price hikes that have pushed up inflationary pressures.
Traders are betting that the Fed will do more to raise interest rates
The fundamental difference – until now, however – is that in the 1970s, expectations of consumer inflation drifted away from policymakers at central banks in Canada and elsewhere. Policymakers have sat idle for too long, letting inflation take root in the public’s thinking — making the task of taming it increasingly difficult, and the damage intensifying.
“The issue for central banks is that they need to be careful not to let the genie’s expectations come out of the bottle… which we didn’t do in the 1970s,” he said.
Mr. Dodge – who led the Bank of Canada from 2001 to 2008 – believes the central bank’s mission is clear: to raise its policy rate, and quickly, to shut down rising inflation expectations before it is too late.
“They need to get up on that, get on with that fast, to break expectations as quickly as they can — definitely by summer.”
The Bank of Canada raised its key interest rate by 50 basis points (half a percentage point) in April, twice the size of a typical bank rate change – the first sign of the urgent need for significantly higher interest rates in the face of Canada’s highest inflation in three decades. Mr. Dodge is adding his big voice on monetary policy to the growing group of experts who believe the bank should be more aggressive.
He argues that the bank should raise the rate by “50 points or even 75 points” in its rate decision in early June, “followed by another 50 points or so” in the next decision in mid-July. That would quickly put the rate in the 2 to 3 per cent range that the central bank estimates to be in a “neutral” territory – where it neither stimulates nor dampens economic activity. The current rate of 1 per cent remains a catalyst for the economy – hence inflation.
“That doesn’t really seem appropriate at a time when inflation is much above target,” he said.
Mr. Dodge was on the front lines of the failure of inflation policy in the 1970s. He was a senior official on the Anti-Inflation Council, the federal body that tried – in vain – to cool inflation by imposing government-imposed wage and price controls. By the time the government shut down the board of directors, and the central bank (along with other major industrial countries) finally cracked down on inflation in the early 1980s, interest rates had risen to 20 percent and the economy was pushed into a deep recession. .
A decade later, Mr. Dodge was a senior Treasury bureaucrat when he established the Bank of Canada’s mandate to target inflation and eliminated the federal deficit – two major policy achievements that finally helped stamp out inflation. He then spent seven years as head of the central bank, overseeing the inflation mandate.
One of the main differences between today and the 1970s – as current Bank of Canada Governor Teff McClem has pointed out – is that we now have a track record of 30-year central bank monetary policy that has successfully defended a 2 per cent inflation target. As a result, the Bank has firmly set its long-term inflation expectations around this target.
“It took a show to bring down inflation, it took time, for inflation expectations to prove well on target,” McClem said. “This is a huge asset that we have today. It is also important that we preserve these assets.”
But Mr. Dodge says the economic climate resulting from the pandemic poses a qualitatively different inflation problem than the one that central banks and governments have dealt with in previous years. A variety of factors—from an aging workforce, to a net-zero carbon transition, to geopolitical conflict, to a growing push to redraw the supply chain and trade maps—point to supply constraints as a key driver driving inflation, rather than the traditional demand factors that policymakers are accustomed to. on her.
“I think we should be prepared to think of a world that is much more restricted in terms of width than we were used to in the first nineteen years of this century,” he said.
This means that central banks will be limited in what they can do to influence inflation; Their primary tool, interest rates, is largely geared towards driving and attracting demand. This is clearly a major concern for Mr. McClem and other central bank leaders, as they act aggressively with rate hikes – amid more than a little uncertainty about the impact these moves will have in this changing economic landscape.
“You can see it in the body language of both Tiff and [U.S. Fed chair] Jay Powell… they don’t want to move [rates] So they kill everything and create a bigger problem. They are tense. This is reasonable.”
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