Maxime Bernier

Should we change the Bank of Canada’s inflation target?

Should we change the Bank of Canada’s inflation target?

13 November 2009

Hello,

About two weeks ago, on October 27, I asked a question about the Canadian dollar to Bank of Canada governor Mark Carney who was appearing before the Standing Committee on Finance.

Over the past few weeks, Mr. Carney has stated several times that he would intervene to push down the dollar if it gets too high compared to the US dollar.

As you will see in the following excerpt, he agrees with me that there are advantages as well as disadvantages to having a strong currency. But his answer raises an interesting point about the way the Bank of Canada conducts its policy.

Question: You have said several times that you will not hesitate to intervene if our dollar goes up too much against the US dollar.

From your declarations, we get the impression that a strong currency only has negative consequences, for exporting businesses and for economic growth in the short term.

However, a strong currency also benefits consumers by making imports cheaper; travelers who go to the United States; businesses who import equipment from the US; and investors who invest in other countries.

Also, there would be negative consequences if you intervened to prevent it. It would mean creating Canadian dollars in order to debase our own currency as fast as the Fed is debasing the US dollar. It is generally recognised that during the Great Depression, competitive devaluations made the crisis much worse.

So I would like to ask you if you agree that there are pros and cons to a higher Canadian dollar and if so, how do you proceed to make a balanced decision that takes all these factors into account?

Thank you.

Answer: Mr. Bernier is right, there are positive and negative conséquence to the strength of our currency. But what matters in the end is the impact of the exchange rate, coupled with all other internal and external factors, on global demand and the inflation rate in Canada. This is what determines the monetary policy of the Bank of Canada.

(NB: This is not a verbatim transcript but rather an adapted translation of the notes I used for my question as well as Mr. Carney’s answer.)

His answer is very clear. What determines the policy of the Bank of Canada is the impact of the exchange rate and all other factors on global demand and on the inflation rate in this country.

Whatever advantages or disadvantages there are to having a strong dollar, Mr. Carney says essentially that this is irrelevant, and only counts insofar as it affects the rate of price inflation.

As you may know, there is an agreement between the Bank of Canada and the Finance Minister to aim at a price inflation target of 2%. Right now, the price consumer index in Canada is below 0%. So, to meet its target, the Bank has to carry on a policy that will increase the rate of price inflation. One of the things it has done to achieve this goal was to drive interest rates close to zero.

This is also why Mr. Carney doesn’t like to see the Canadian dollar increase too much against the US dollar. This has the effect of lowering the price of imported goods and making business more difficult for Canadian exporters. It consequently drives down the rate of price inflation even more. Mr. Carney instead wants prices to increase faster. And so he says he is willing to intervene.

He would do this by creating Canadian dollars out of thin air and buying up US dollars with them, thereby pushing down the price of Canadian dollars on currency markets.

Now, as I have said many times in the past, I don’t believe monetary and price inflation is a good thing for our economy and for Canadian consumers. Inflation is the equivalent of a tax in that it devalues the money that we have in our pockets and bank accounts. It is true that most of us get salary increases that compensate for the loss of purchasing power. But those whose income doesn’t increase as fast as prices get poorer.

Monetary Inflation is a hidden way of redistributing wealth from some groups to others within our society. It also creates all kinds of market distortions and is the cause of the booms and busts that our economy has been going through.

The agreement on the price inflation target between the Bank and the minister of Finance is set for five years and has to be renewed next year, in 2011. I think this is a very good time to have a debate on the consequences of inflation. Should we lower the target to 1%? Or if inflation is bad, why not to 0%?

Come back to my blog if you want to hear more about this issue.

Thanks for listening and see you soon.

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