Finn Poschmann: Carney era dead at Bank of Canada

It’s back to the future for the Bank of Canada, which has dumped questionable Carney innovations

Patrick Doyle/Bloomberg

Yesterday’s Bank of Canada interest rate announcement, accompanied by a preannounced downgrade to its economic forecast, triggered a wave of business headlines including variations on the word “gloom.”


Striking that the revised growth outlook was not news, and neither was the Bank’s complete inaction with respect to the overnight interest rate target – the only rate the Bank controls. What instead caught the gloomwatchers’ eyes was the Bank’s blunt refusal to reiterate past statements to the effect that short-term interest rates should be expected to go up when market conditions warranted.

And this is the topsy-turvy world to which bank transparency, supposed clarity in communications, and “forward guidance” have delivered us.

Background. In the very early 1990s, the Bank of Canada adopted an inflation-targeting imperative, and was then so uncertain about its ability to deliver on it that the Bank edged in sideways, with a commitment only to bringing down the rate, and eventually to review the plausibility of a 2% long-term target.

It was only by 1995, arguably, that markets began to believe it could be done, and so too did the Bank.

Poloz’ sphinx-like approach signals a different and healthy route

The mission was so effective that macroeconomic forecasters began to argue less about what inflation assumptions entered their models. Businesses and investors began to worry less about how domestic inflation might affect their financial commitments, and could pay more attention instead to the soundness of business plans, and limit their hedging costs to exchange rate risk and interest rate risk, with inflation as a given.

The Bank of Canada had put hitting the 2% headline CPI target at the top of its to-do list. In its having done so, markets came to understand that rate announcements would not cause shocks or be independent sources of market volatility. Inflation expectations would not wander, and businesses could adjust to market conditions and exchange rate changes, driven mostly by market and monetary factors elsewhere.

And the idea worked. So effectively that the reduction of inflation risk, or the taming of expectations, have since been blamed for financial stability that allowed “irrational exuberance” to take hold. Of course, irrationality has many sources, but tamed inflation is not one of them.

So things were in Canada, until end-2008, when we were struck by a financial meltdown whose sources lay elsewhere but landed here, too. In early 2009, then-Governor Mark Carney introduced the concept of a promise to maintain low rates for a long time, with some warnings about when that might end and under what conditions.

And Bank staff worked consistently to explain what that meant. They signalled accurately the withdrawal of the commitment, they removed it, and there was no market shock. Such limited guidance was a success then.

Beyond that, there is very limited evidence that central bank guidance provides clear benefits, and recent events in the U.S. and UK point much the other way. In the latter countries, central banks have taken aim at unemployment rates, describing thresholds or, in the UK, multiple “knockouts” that might, maybe, under some conditions, lead them to change policy sooner than otherwise. Given that unemployment rates are not readily in the grasp of monetary policy, it should hardly surprise that markets have taken such messaging with a grain of salt.

Unsurprisingly, central bank announcements in the U.S. and UK have produced continuing market volatility, notwithstanding plenty of guidance and rhetorical clarity in communications. This failure will prove harmful to central bankers’ credibility, to the power of monetary policy, and to investment planning and economic outcomes.

In Canada, though, what perturbed financial journalists Wednesday, more so than the day’s anticipated market unrest, was the terse phrase, “the Bank judges that the substantial monetary policy stimulus currently in place remains appropriate and therefore has decided to maintain the target for the overnight rate at 1%.”

No statement of “bias,” in the current jargon, and no “guidance.”

Which, of course, is exactly how it should be. Governor Steve Poloz’ sphinx-like approach signals a different route from the U.S.’ and the UK’s, and a healthy one. The Bank will stick to its inflation target and otherwise respond to conditions. There might one day be a reason to make a longer-term statement, yet clearly it sees no reason to do so now.

Limited and clear wording, with retention of a focus on the inflation target, will be understood by markets. And an inflation target is one goal a central bank can eventually deliver on, if it focuses only on that.

“All in all, a good news day for Bank of Canada policy. In other news, and notwithstanding dire warnings at market open and down markets elsewhere, the TSX was mostly up on Wednesday, and closed flat on the day.”


