The Bank of Canada needs more restrictive interest rates to control hyperinflation

People shop at Walmart Supercentre in Toronto on March 13, 2020. Canadian inflation accelerated to its highest rate in nearly four decades in May as calls for policy makers widened to find new ways to curb runaway price growth.Carlos Osorio/Reuters

With each new inflation report, the job facing the Bank of Canada becomes more difficult.

An alarmingly rising tide of inflation – it reached 7.7 per cent in May, the highest in an astounding 39 years – is pressing the central bank to respond with larger and faster increases in interest rates. The right place to do the bleak job properly shrink. The risk of being exposed to an error – stagnation is increasing.

Soft landing of the economy? Certainly, this is still a dream. But as the task of curbing inflation continues to grow, it may take more luck than skill to get there. Honestly, sensitivity isn’t the top priority at this point.

“The most important thing is to get inflation back on target,” Bank of Canada Deputy Governor Caroline Rogers said at the Globe and Mail event two hours after the inflation report was released. Of course, we want to do this with as few unintended consequences as possible. …that’s what we aim to do, and that’s why we’re increasing rates. That’s why we’re doing it so fast.”

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The May inflation report, published by Statistics Canada on Wednesday, likely bolstered a 75 basis point (three-quarters of a percentage point) rate hike by the Bank of Canada in its next rate decision in mid-July – which would be the bank’s decision. . The largest single-volume increase since 1998.

Frankly, you could make a compelling case for more information, given the situation and timing.

The central bank has repeatedly said that it wants to quickly raise its key rate, at least to levels it considers “neutral” – that is, where its rate neither stimulates nor inhibits economic activity. It estimates the neutral rate to be between 2 and 3 percent. A 75 basis point hike in July would put the price at 2.25 per cent – still towards the lower end of the neutral range.

While the odds of a July increase of a full 1 percentage point don’t seem high at this point, there are some good reasons for the Bank of Canada to seriously consider this option. Such a rally would put the bank in the middle of its neutral range, which at least fulfills the first stage of the bank’s interest rate intentions. It could say it withdrew its stimulus rates, before switching to summer mode after the July rate decision – a long period of relative public silence that lasts until the next rate decision after Labor Day.

The Fed is also set to set its key rate two weeks after the Bank of Canada announced in July, and appears poised for its own jump to 2.5 per cent. The Bank of Canada may want to keep pace with its US neighbor proactively before leaving in the summer.

No matter the amount, it is increasingly clear that simply returning to neutral rates will not be close enough. The bank will need more restrictive interest rates if it is to apply some serious brake on domestic demand, which is far ahead of being able to provide. Bottom line, the bank needs to slow the economy.

It should be possible, at least computationally, to do so without causing the kind of functional stagnation that is the hallmark of any true stagnation. As Statistics Canada reported this week, Canada had nearly a million job vacancies in the first quarter, at a time when the unemployment rate has been low in 50 years — evidence of a massive gap between labor supply and demand. Bank of Canada officials said this leaves plenty of room to dampen demand – such as an area of ​​one million jobs – before it starts to significantly hurt the job.

“We see a way to do that. Our view is that we can take some of the excess demand out of the economy, and rebalance it,” Ms. Rogers said.

But just because the numbers work doesn’t mean engineering such a feat is easy. far from it. And any central banker – commonly understood to be involuntary – will tell you that interest rates are a blunt tool. They are not at all suitable for the economical micro-surgery we are trying to perform here. Nobody can really tell how high the prices are or how fast you have to go up to that cool spot where we hit the brakes on demand without bumping our collective heads into the windshield.

If you’ve been watching this game for a few economic cycles (old man disclosure: I have), you know from experience that by the time you hear and read the phrase “soft landing” everywhere, that possibility is almost certainly has already come and gone. Oftentimes, it is wishful thinking for those who can see the Earth rapidly approaching from beneath it.

On top of that, it’s past time for the Bank of Canada to worry about being too nice. It just needs to drive inflation to the ground – in any way possible – before a terrible year begins to fester and turn into a generation problem. Yes, things have become that serious.

Prepare for shock.

Interest rates and inflation are closely related, which is why the Bank of Canada raised its key interest rate to try to keep inflation at its 2% target. But it is a delicate balance between controlling inflation and not pushing the economy into recession.

The Globe and Mail

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