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Why it is so hard for the Bank of Canada to crush inflation

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Those who think central banks are powerful and manipulative may ask themselves why people like Senior Vice-Governor Carolyn Rogers aren’t snapping their fingers and killing inflation.

Officials at the Bank of Canada have vowed to be “resolutely” committed to squeezing inflation, bringing it down to the bank’s target range of 2%. But as interest rates continue to rise, that process can be long and painful.

As Rogers warned on Thursday that Canada was facing an “expectation spiral,” trying to change the direction of inflation is akin to changing the Titanic after finding an iceberg in the fog. increase.

the economy is too strong

The Canadian economy is not on the brink of sinking. Instead, the problem Rogers raises is that the economy is too strong.

“Demand continues to outstrip supply in many parts of the Canadian economy, and Canadians’ short-term inflation expectations remain high,” Rogers told Calgary Economic Development, a privately and publicly funded agency.

The solution, Rogers said, was to use the sharp rise in interest rates to squash demand and provide an opportunity for supply to catch up.

The plan, as the European Central Bank also announced on Thursday, is to do what they call ‘front-loading’, with several large interest rate hikes in a row to shock markets. That’s it. Rogers said this was “an attempt to avoid the need for further rate hikes in the future and the accompanying more pronounced slowdown in the economy.”

Bank of Canada Senior Deputy Governor Carolyn Rogers said the bank does not have an interest rate target, but it does have an inflation target, in the range of 1-3%, well below current rates. (Julie Gordon/Reuters)

Despite the risk of the central bank “overshooting” interest rates too high and pushing the economy into a deep recession, the Bank of Canada maintains that a soft landing is still possible.

But for now, the problem is falling inflation, and central banks around the world face many obstacles.

Fiscal spending, such as consumer energy subsidies in Europe and social assistance funds in Canada, is going in the opposite direction that central banks want. And the rate hike itself could make things more expensive.

Global inflation could push Canada’s import costs higher, but Looney’s rise could act as a pad against these inflationary effects. No guarantees, he said.

why lag?

Another problem that central banks face all the time is that their current interest rate cuts or hikes may not be reflected in the economy for years. Rogers said the same thing is likely to happen this time around.

In this way, frontloading gives the central bank an opportunity to use smaller rate hikes once it reads indicators such as GDP, employment numbers, and other data and sees how the economy is reacting. can help avoid overshoot.

Private consumption and wage demand are where it is relatively easy to see the lag between rising interest rates and slowing demand.

As others have noted in the past, the accumulation of savings by those who can afford to save during the pandemic means that retail spending will not necessarily respond immediately to rising interest rates. said it continues to monitor these savings and is far from depleted.

Watch | Central Bank’s Inflation Control Plan:

Bank of Canada raises interest rate to 3.25%

The Bank of Canada raised interest rates again on Wednesday, signaling it likely needed to raise them further to curb runaway inflation. This is grim news for economically-strapped Canadians who are already struggling with skyrocketing inflation, unmatched wages and credit card debt.

House prices have already fallen due to higher interest rates, making it harder to get a mortgage at the level of just a year ago, she said. But these higher rates are only slashing people’s budgets.The rate hikes will only become apparent to most mortgage holders, perhaps for years, when they renew. increase. Consumer loan costs such as cars only become part of the budget when people decide to buy a new car, which is rare.

Rogers said so far the spiral of expectations she described has been driven, at least in part, by labor shortages. We expect that this indicates that we continue to create

Central banks and others are eyeing wage increases announced by Statistics Canada last month. Wages rose at a rate of 5.2%well above the Bank of Canada’s inflation target.


Short-term expectations and retention

“The labor market is very tight, in an environment of excess demand and high inflation,” Rogers said when asked by reporters. “We know employers are very focused on attracting and retaining employees.”

Nevertheless, she said it is not the central bank’s job to set wages or prices.

“We also understand that workers are looking at the rate of inflation and its effect on their purchasing power and thinking, ‘I need a pay rise.’”

Members of the British Columbia General Employees Union (BCGEU) picket outside the BC Liquor Distribution Branch facility in Delta, BC on August 15th. (Daryl Dyke/Canadian Press)

But by raising interest rates, the bank hopes to prevent short-term inflation expectations (which we’ve already seen) from turning into fixed expectations, which she defined differently.

“The scenario that worries us is that Canadians are looking at the current rate of inflation. They think it will continue. I have.”

Just this week, public officials in British Columbia opposed wage increases that were below current inflation but well above the central bank’s target. The deal negotiated after the 95% strike vote was seen as a model for other workers Across Canada, wages are well below inflation.

5.5% wage increase in the second year

The settlement, which union members have yet to ratify, proposes a price increase of 3.25%, dating back to April this year. But next spring, when banks expect prices and wages to start falling, Workers receive at least 5.5% Raise wages — more if inflation remains high.

This trade shows a second example of the lag after the central bank starts raising rates. As other contracts and negotiations come due, each group in turn feels the need to catch up with other wage increases. It, too, can unfold over the years.

On the bright side for Rogers and the central bank’s hopes of lower inflation, BC’s employee deal will offer workers up to 3% in the final year of 2024-2025. This is well within the Bank of Canada’s inflation target range.

But to borrowers worried about how high Canadian interest rates could rise, Rogers said she wouldn’t say anything because neither of them are sure.

“We don’t have an interest rate target,” Rogers said. “We have an inflation target.”

Follow Don on Twitter @don_pittis

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