Finance Committee on Nov. 15th, 2011

[Prof. Mario Seccareccia]

Jim already mentioned in his presentation that the Bank of Canada has been a little more flexible than simply the inflation target in a reality. If you look at what they did, for instance, in April 2009 all the way to June 2010, where they pegged the overnight rate at the lowest possible level and left it there, that would suggest that maybe they were very concerned about the crisis at that time and acted appropriately, I would say, in this case, just as the Federal Reserve is doing right now. So in fact, even though they don't have that as an actual mandate in their function and they only look at the inflation rate, in reality they do look at others.

To suggest also that somehow we cannot define full employment or any sort of high level of employment is absurd, not only because we also have a problem with inflation, but the central bank has been concerned with the NAIRU over the last 20 years, you could argue, or with potential GDP growth. That is a similar problem.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Mr. Julian.

We'll go to Ms. McLeod, please.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

Thank you.

I really appreciate the expertise that we have at the table here today, and certainly from the testimony we've heard, it doesn't seem like this is an easy subject to actually wade one's way through.

I would like to first of all give Mr. Ragan a chance to talk a little bit further about your “constrained discretion” comments.

[Prof. Christopher Ragan]

Thank you. This will relate to comments that Jim and Mario just made.

You will notice, if you've read the Bank of Canada's background agreement, that they talk about the flexible inflation-targeting framework. While that word may have been used less in the past years than it is used now, in that document the concept of flexibility has always been an important part of inflation targeting. It's completely consistent, in my view, with Mario's description of the conditional commitment that was given in April 2009 by the Bank of Canada.

In my view, the flexibility is equal to these words, “constrained discretion”. The constraint is the bank has a very clear objective to try to keep inflation low and stable and close to 2%. We sometimes talk about 2% as the midpoint of a 1% to 3% band. Sometimes less emphasis is placed on the band, but the target is clearly 2%. The discretionary part is the bank has latitude. Following a shock of various magnitudes, various sources, the bank uses its discretion, or, if you like, its judgment, to choose the route back towards that target.

One of the things that's always been true about inflation targeting is that there's a recognition that central banks' actions can't influence inflation immediately. Their actions today to influence, for example, the target for the overnight rate influence employment over a future interval of three or four quarters and inflation over six or eight quarters in the future. So what you'd expect in a system of constrained discretion is that when negative or positive shocks of various kinds hit the economy, as was true in 2008-09, the bank would have the flexibility to lower rates. In this case they issued a conditional commitment, but it's a conditional commitment that they would keep rates low, conditional on the performance of inflation. If inflation started to pick up, then they reserved the right to raise rates, as they did eventually.

What you'd expect in that system is if they were both constrained by the target but had the ability to use their discretion, you'd expect inflation to average at the target, as it has, but you'd expect inflation to deviate from the target over the business cycle in response to various shocks, which it has. I think this constrained discretion is an important part of understanding Canada's inflation-targeting system.

The bank does care about real GDP; it does care about unemployment. The bank publishes its estimate of the output gap, which is the difference between real GDP and full employment GDP. And it views its goal as keeping inflation on target by keeping output close to potential, and that's why it builds that into its operations, if you like.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

I know there were some arguments for different focuses, measurements, but given the fact that for the next five years we have gone in terms of the 2%, is the 2% an appropriate target, an appropriate rate? Is 1% to 3% an appropriate range? I know there are arguments for and against other measures, but I believe Mr. Alexander indicated support for that target and range.

Are there any other comments?

[The Chair, Conservative, James Rajotte]

Mr. Alexander, do you want to...?

[Craig Alexander]

I covered it in my remarks. I think 2% is the right target.

[The Chair, Conservative, James Rajotte]

Who would you like to answer this?

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

Anyone can jump in on this.

[Dr. James Stanford]

If I were to follow an inflation-targeting system, which I indicated I think is not adequate, I would suggest the target should be higher in light of some of the economic evidence from the last couple of years about the problem of the zero-bound, where interest rates can't go below zero, even at times when you need more stimulus. Within the realm of inflation targeting, I think there's an argument for a higher target.

[The Chair, Conservative, James Rajotte]

Okay, there is time for a couple more brief comments.

[Prof. Mario Seccareccia]

I think we need a broader band or range, as indeed Jim was also suggesting, but also we should include another variable in there. If you take the U.S. case, it's governed essentially by the Humphrey-Hawkins Full Employment Act of 1978, and they're still committed to those basic principles that guide the governor of the Federal Reserve as well, which includes unemployment there. That's the point I was trying to make earlier, which is that we should have both a broader band for the inflation rate as well as some sort of concern about where we should reach in terms of some employment targets.

[The Chair, Conservative, James Rajotte]

Mr. Ragan, briefly, please.

[Prof. Christopher Ragan]

I would be in favour of maintaining the inflation targeting system. I think 2% is a reasonable target. I certainly would not suggest increasing the target. I see no genuine or likely benefit from increasing the target. I would consider reducing the target, although I think there's a legitimate debate about whether the benefits from lowering the target to 1.5% or 1% would outweigh the costs. I think that's a legitimate debate. I think the case is much weaker for raising the rate.

[The Chair, Conservative, James Rajotte]

Thank you very much.

We'll go to Mr. Brison, please.

[Scott Brison, Liberal, Kings—Hants, NS]

Thank you, Mr. Chair.

And thanks to each of you for your input today. It's very helpful to us.

Dr. Sumner, you're familiar with Nick Rowe's blog. Mr. Rowe sits on the C.D. Howe Monetary Council. On his blog recently, Rowe compared CPI and nominal GDP trend lines for the Canadian economy, and since 2008. What effect do you expect that nominal GDP targeting would have had on Canadian unemployment levels compared to status quo inflation control targeting?

[Scott Sumner]

I have that right in front of me. It looks to me like even with inflation targeting, Canada might have been able to do a bit more, but certainly with nominal GDP targeting the Bank of Canada would have been significantly more aggressive in the last three years and unemployment would probably be somewhat lower today.

As I said before, it's not a miracle worker. I think the advantages are probably greater right now for the U.S. and Britain, but I think even for Canada, looking at this data--I also looked at some labour market data on wages and so on--it looks to me like a little bit more expansionary monetary policy would have been beneficial over the last three years.

[Scott Brison, Liberal, Kings—Hants, NS]

The Bank of England has been missing its inflation targets and is also experiencing weak economic growth at the same time. What would be the potential advantages for nominal GDP targeting and inflation control targeting, the pros and cons of each, in the context of the U.K. experience? Generally, how would nominal GDP targeting compare with alternatives during a period of stagflation, where we have high unemployment and high inflation at the same time?

[Scott Sumner]

That's a good question. In the case of Britain, I think there's a fairly general understanding that Britain needs more stimulus right now. The economy is very weak and the problem the Bank of England has is there's a desire to provide it but it feels very uncomfortable with the fact that it would be violating the inflation mandate. So it's sort of dancing around the issue a little bit but it's not moving as aggressively as it would like, in my view, because of the inflation mandate.

In terms of stagflation, monetary policy can't really solve long-term real growth problems, but I think what it can do is provide better performance when there's a temporary supply shock or productivity issue. In the case of long-term growth, just to react a little to what Chris and David said, there is a problem if there are demographic changes. One way of addressing that is to use nominal GDP per capita or even for the working age population. That's more likely to give you better results, because what really matters is nominal output per worker or potential worker in the economy, which you want to keep as stable as possible.

When there's a sort of supply problem, if you have inflation targeting, you're forcing all the adjustment on wages, and wages don't tend to be very flexible, so you tend to get fluctuations in employment. With nominal GDP targeting you allow some variation in inflation, which helps provide equilibrium in the labour market. It's going to provide a little bit better performance in terms of jobs, again without changing your long-term rate of inflation.

Now, given all the discussion revolving around the recession, people tend to think of nominal GDP targeting as being more expansionary than inflation targeting or perhaps allowing inflation to get out of control in some sense, but I think that's very misleading. In the long run, you're going to get the same inflation rate. It's also true that during boom periods, such as the American housing boom, you probably have a little tighter monetary policy. So the long-term inflation rate won't differ, and I would argue it's really the long-term inflation rate that you want anchored, not the year-to-year variation.

[Scott Brison, Liberal, Kings—Hants, NS]

In August, Canada had 0.3% growth in our GDP, but that was largely due to the 2.8% growth in energy. Canada has a commodity-based economy, or it does in parts of our regions of our country. Alberta and Saskatchewan as provinces benefit significantly from growth in commodity prices, but that drives inflation numbers, and at the same time it crowds out jobs in other parts of the country and in manufacturing. In light of that two-tier economy, that bifurcated Canadian economy we have because of commodity issues, does nominal GDP as a target potentially become more attractive to at least consider?

[The Chair, Conservative, James Rajotte]

Just a brief response, Mr. Sumner, please.

[Scott Sumner]

I think it does. It would provide a better cushion for the manufacturing parts of Canada, Ontario and so on. I also will just briefly add that Canada was a little bit lucky by the high commodity prices in the last few years. Normally during worldwide recessions, commodities would do much worse, so I think that part of Canada's superior performance to America and Britain was based on the luck of having high commodity prices during a sluggish period for the developed world economy.

[The Chair, Conservative, James Rajotte]

Okay, thank you.

We'll go to Mr. Hoback.

[Scott Sumner]

It might not happen again.

[Randy Hoback, Conservative, Prince Albert, SK]

Thank you, Chair.

Thank you, gentlemen, for being here this morning.

This is an interesting debate, and it's one that I find really interesting for the country of Canada, because the country of Canada has so many different sectors and regions to it. That's where I get to my first question, and maybe, Mr. Ragan, I'll go to you.

When you see different parts of the country, some experiencing a boom and other parts experiencing a recession, how do you account for that as you look at a model for setting monetary policy for the country as a whole?