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Pierre Siklos: Is it broke? Revisiting the Bank of Canada’s mandate

Commentary

The mandate of the Bank of Canada is to keep inflation in the Consumer Price Index (CPI) within a range of one percent to three percent, with a two percent target (IT). It is frequently overlooked that the Bank of Canada Act also states that the Bank must “…promote the economic and financial welfare of Canada.”

The current policy regime, if renewed, will begin its fourth decade. As former Governor Gordon Thiessen argued almost 25 years ago, other strategies may also deliver good macroeconomic outcomes, but “….the benefits of the clear operating framework provided by such targets will make them increasingly attractive in democratic societies that demand accountable public institutions.” Accountability is the cornerstone of good governance because monetary policy is managed by appointed, not elected, officials.

Central banks often evaluate inflationary pressures by estimating the amount of slack in the economy. When slack is low, the Bank can ease monetary conditions, and vice-versa when production exceeds the economy’s potential. The Bank’s estimate of slack or output gap is shown below, alongside U.S. data. While the U.S. Federal Reserve adopted an IT of two percent, it serves only as a guide since the Federal Reserve has a dual mandate of maintaining stable prices and economic activity around potential.

While U.S. and Canadian macroeconomic performance has been comparable, slack is often smaller (and less volatile) in Canada. Therefore, the output is closer to potential in Canada (U.S. average real growth is 2.29 percent versus 2.12 percent for Canada between 1992-2021). Unfortunately, whereas inflation is observable, slack is unobserved and must be constructed. Unsurprisingly there is considerable debate about how much slack exists at any given time.

Economic slack in Canada and the U.S. Note: Canada’s output gap is one estimate from the Bank of Canada; the U.S. estimate is from the Congressional Budget Office. The shaded areas are where Canada’s output gap is smaller than in the U.S. Graphic Credit: Janice Nelson

Accountability implies transparency. Critics of the current policy regime need to ask whether alternative strategies can improve economic prospects clouded by a pandemic. The simple answer is no. Historically, neither exchange rate pegging nor the targeting of monetary aggregates meets the standards of transparency. The former because it disguises broader economic imbalances that usually lead to a collapse of the regime; the latter because it is subject to the whims of money supply definitions. Nominal GDP targeting is also sometimes mentioned as a solution. However, it gives considerable latitude to policymakers, when aiming for a stated target, to change the weight they will place on inflation versus real GDP growth. The dual mandate presumes that the Bank is unconcerned about real economic performance. Yet, Canada’s legislation asks the Bank to concern itself with the country’s overall economic welfare.

Assuming that some version of inflation targeting defines the Bank’s mandate beyond 2021, can any improvements can be made to the existing framework? It is worth briefly looking at history. The graphs below divide history into roughly two 15-years long halves. The first period begins shortly after targets were introduced until shortly before the Great Financial Crisis of 2008-2009. The second period begins thereafter until the present. Straight lines show what happens to CPI if annual inflation is exactly one percent, two percent, or three percent starting from the beginning of each period. The black line shows how actual CPI evolved over time. Actual inflation drifts around the two percent target for as long as we’ve had an IT. There have been no real threats to breach the upper or lower edges of the target range. Nevertheless, the CPI has tended to drift away from the two percent objective for considerable periods of time. While the first period overlaps with what former Fed Chair Ben Bernanke called the Great Moderation, the era since the end of 2007 has been anything but placid. The Great Financial Crisis, the Eurozone debt crisis, and the ongoing pandemic have dominated economic events since 2007.

Graphic credit: Janice Nelson

How much credit should the Bank get? There are those who have argued that luck helped many central banks until 2007 thanks to small surprises (called shocks by economists). The rise of China as a global economic power may also have helped moderate price increases.

Something else happened after the Great Moderation ended. The policy rate, an interest rate used by the Bank to keep inflation under control, was on average 4.35 percent until the end of 2006. Since that time the average policy rate has stood at 1.24 percent. This is a substantial decline that shows no signs of being reversed any time soon.

Canada’s inflation performance. Note: CPI is series v41690914 from CANSIM, which is the monthly seasonally adjusted consumer price index. The one percent, two percent, and three percent inflation rates are assumed to be annual beginning in 1992 when the series is first available, and then again beginning December 2016. Graphic credit: Janice Nelson

Next, central banks in Japan, the U.S., Europe, and the UK purchased financial assets of various kinds and generally eased credit conditions. The collection of these policies is termed quantitative easing (QE). The Bank also joined the QE club when the pandemic erupted since there was little scope to ease monetary conditions via interest rate cuts. Measures were taken, such as the purchase of long-term government bonds, provincial bonds, and even corporate bonds. As a consequence, the Bank’s balance sheet swelled 11-fold between the end of 2006 and its peak, reached in February 2021. To its credit, the Bank ended QE in October 2021as pandemic conditions ease. While the balance sheet will shrink over time it is also likely to remain at historically elevated levels for the foreseeable future. Nevertheless, this episode, along with other ongoing economic and societal forces, has potential repercussions for the Bank’s mandate going forward.

Returning to the Bank’s performance, another measure of its impact is reflected in how well it steers the public’s expectations about future inflation. After all, if the central bank is committed to two percent inflation, then the public should have confidence that it will deliver it in the future.

The evolution of inflation expectations in Canada. Note: The left-hand scale measures consumers’ expectations. The right-hand scale is the proportion of businesses surveyed who believe inflation will remain in the one to three percent target range. All data are from the Bank of Canada’s Survey of Consumer Expectations, introduced in 2014, and the Outlook Survey. Graphic credit: Janice Nelson

Other than in 2009 and again following the pandemic, the majority of businesses believe inflation will remain in the one to three percent target range. However, notice that it does not take long for bad news about inflation to reverse businesses’ faith in the target. The public, on the other hand, is less confident, with inflation expectations over the next two years close to the top end of the target range. Notice the volatility of one year ahead expectations, which may indicate that consumers are quite sensitive to recent news about inflation. Ideally, central banks aim to anchor expectations at two percent. The burning issue now is whether the recent rise in inflation is transitory or more permanent. If the anchor is lost then the upper range of the IT will be threatened, as will the Bank’s credibility. Faith in the maintenance of the target is fragile and any mandate must seek to strengthen the public’s view about the Bank’s ability to achieve its target.

Where do we go from here? The old adage: “If it ain’t broke, don’t fix it” applies. However, the Bank faces greater threats. Even before the pandemic, climate change, inequality, and lacklustre economic growth, to name just three issues, were challenges faced by public officials. The arrival of digital currencies may tempt some governments to ask central banks to issue the proverbial “helicopter money”. QE, largely essential over the past 18 months, will return if the economy continues to disappoint. Japan has relied on QE-style policies for over two decades while the U.S. has followed the same strategy for well over a decade. While there is a case to be made that, absent QE, economic performance would have been worse, QE did not reverse the low inflation-low growth combination. Clearly, monetary policy is not enough.

It has always been true that monetary and fiscal policy must function in concert. A reminder is needed that the central bank is an institution within government and not outside of it. The greater risk is that central banks will be asked to do too much, not whether or not a new form of IT is adopted. A cynic would argue that this suits politicians because the blame for poor outcomes can be shifted elsewhere. A more charitable view is that to promote the welfare of Canadians, monetary and fiscal authorities must work together. It is the checks and balances provided by the institutions jointly responsible for monetary policy and financial stability that provide the best guarantee of accountability. The Bank’s focus on inflation is the best guarantee against a mandate that tries to be all things to all people. However, once the target is renewed, the contract between the central bank and the government will need to be improved.

Sean Speer: What elite commentary gets wrong about J.D. Vance

Commentary

One of the highest-profile candidates in the United States’ 2022 mid-term elections is Ohio Republican senate candidate J.D. Vance, who came to prominence in 2016 due to his best-selling memoir, Hillbilly Elegy, which detailed his life growing up in working-class conditions in Appalachia. 

The book, which was a massive commercial success, including an endorsement by Oprah Winfrey and a subsequent Netflix film adaptation directed by Ron Howard, brought mainstream expression to the socio-economic conditions in the American rustbelt that contributed to Donald Trump’s shocking election in 2016. 

At a moment when the elite commentariat was searching for answers, Vance provided a first-person window into a world that they didn’t know or understand. He was instantly shot into superstardom. 

His mix of personal trauma, military experience, and a Yale degree made him a powerful voice for those Americans suffering from the consequences of de-industrialization, family breakdown, and the opioid crisis. He spoke about these issues with a unique combination of empathy, nuance, and personal connection. Vance’s story was fundamentally a meritocratic one (and in turn resonant with elite voices): he succeeded based on a combination of his intellect and initiative and in spite of his household and broader community failings. 

Although his politics were broadly conservative, his temperament was moderate, his ideas were balanced, and he was explicitly anti-Trump. He was widely accepted in elite circles from the Aspen Ideas Festival to the New York Times’ editorial page

Back in those halcyon days of early 2016, one had the sense that Vance represented just about America’s best hope at bridging the country’s political divide. He had Red State sensibilities and Blue State credentials. He projected a unique ideological and political amalgam (including a message of personal responsibility on one hand and a view that government ought to better support disadvantaged families on the other hand) that might appeal to both Democrats and Republicans in a swing state like Ohio. 

The intervening time has dashed these hopes. American political polarization has only worsened and Vance has categorically chosen a side. No longer an author selling books, and now an aspiring politician competing in a hotly-contested Republican primary race, Vance’s moderation has been replaced by a much harder-edge and uncompromising conservative populism. His inflammatory Twitter posts stand in stark contrast to some of the ideas in his book or accompanying interviews, op-eds, and speeches. 

He’s argued, for instance, in favour of nationalizing the Ford Foundation for its left-wing philanthropic activities, reiterated the famous Richard Nixon quote about how “professors are the enemy” and since come to apologize for his pointed 2016 critiques of Trump. He has in short drifted from a National Review conservative to a Newsmax conservative. 

These changes in Vance’s politics have been noticed by many of the same progressive commentators who were initially interested in him and his book. There have been a series of recent articles and columns in the Globe and Mail, New York Times, and The Atlantic documenting the “shocking transformation” and so-called “moral collapse of J.D. Vance.”

A common assumption across these different commentaries is that the change in Vance’s politics is fundamentally performative: he’s disingenuously trying to replicate the adversarial tone, messages, and topics that vaulted Trump to the presidency for his own political ends. As New York Times columnist Ezra Klein explained in a July 2021 podcast episode: 

“[Vance is a] kind of genteel, thoughtful guy, a venture capitalist for Peter Thiel. [He] writes this book about actual cultural failings in Appalachian white communities and how a lot of it is an individual responsibility collapse. And as he’s become more ambitious in Republican Party politics, he has just turned himself into the weirdest, most awkward, most visible way into this copy of sort of Don Trump Jr… this constant owning the libs and super conflictual on Twitter… [H]e’s a smart guy and he’s reading the electorate. And he has decided, it seems to me, that they want something very different than what he was.”

There’s no doubt that there’s something to this line of thinking. Vance and other Republican office-seekers have clearly assumed some of Trump’s political characteristics including his inherent combativeness. They are indeed reading the Republican electorate and seeing that there’s obvious upside for conservative politicians who take the fight to progressivism and what has come to be described as “owning the libs.”

The so-called “culture war” doesn’t feel like a war at all. It’s a one-sided shellacking. 

The problem with this analysis, though, is that it’s incomplete. By assuming that Vance’s harder-line politics are wholly insincere, these left-wing commentators ignore the extent to which it may be a response to the leftward shift occurring in progressive politics. In particular, they fail to see how the mix of issues and impulses that sometimes gets described as “identity politics” has come to dominate left-wing politics and increasingly mainstream institutions (including large companies, newsrooms, and universities) and in turn contributed to a hardened conservative response. 

Polling shows that in the United States, for instance, the Democratic party has moved more to the left than the Republican party has moved to the right over the past quarter-century or so. That trend only seems more pronounced in the current moment of complicated pronouns, half-mast flags, and the mainstreaming of academic jargon about race, privilege, and sexuality. 

As we’ve seen in a series of recent cases—from Microsoft ads in which staff self-identify their gender, race, and appearance, to the brief yet still notable inclusion of anti-racism text in Ontario’s math curriculum—these issues are no longer merely isolated to the fringes of left-wing politics. They have, as New York Times columnist Ross Douthat observed last week, “permeated the language of many important institutions, from professional guilds and major foundations to elite private schools and corporate human resource departments.”

These developments, it seems to me, are not an insignificant factor in understanding the growing reactionary politics on the right. The pace of cultural and social change is unrelenting, and conservatives have come to feel like mainstream culture and the institutions that dictate and transmit these progressive ideas are increasingly hostile to their own ideas and perspectives. The so-called “culture war” doesn’t feel like a war at all. It’s a one-sided shellacking. 

As the National Post’s Colby Cosh warned in a prescient 2016 column:

“The ‘social conservative’ side of these arguments gains no peace and receives no mercy when it loses, or even when it surrenders. Every new stage in the liberal jihad is a fresh opportunity for progressives to intimidate and castigate the hopelessly backward; the language and tactics used against those on the wrong side of the line grow ever more contemptuous and supercilious, not less.” 

One can certainly think that Vance’s political trajectory is regrettable and wrong. His populist positioning has undoubtedly led him in a reactionary direction. He recently told a conservative audience that “if our enemies are using guns and bazookas, we damn well better fight back with more than wet noodles.” This is a message rooted in what political scientists call “affective polarization”—a politics of zero-sum opposition rather than positive-sum aspiration. Polarization on one side, in other words, necessarily begets more polarization on the other.

It may help him to galvanize core Republican voters, but it will almost certainly constrain Vance’s ability to build a broad-based consensus around his priorities. His brief foray into elected politics has already significantly narrowed his appeal and it’s hard to see a scenario where he’s able to recover it. Social media and the internet are permanent after all. 

There’s also a case that Vance’s political strategy underestimates the broad appeal of the core messages of Hillbilly Elegy, which were about social mobility, personal initiative, and the role of civil society, broadly defined, to help those who are striving for a different and better life. In an alternate universe, it would be instructive to run a parallel campaign that tests the hypothesis that a 2016 version of Vance could actually find a large audience of support among core Republicans as well as swing voters.  

But the key point is that it’s not enough to attribute these changes to Vance’s politics to mere political opportunism. That’s a necessary yet insufficient explanation. There’s something deeper going on here. Progressives who lament the loss of another “genteel” conservative ought to ask themselves whether their own uncompromising politics have played a role. 

Reactionary conservative politics has to be, by definition, in reaction to something. That’s the part that Vance’s critics fail to reckon with. They should.