BoC Is Suddenly Able To Tackle Inflation After We Explain To Parliament What They Did

Canada’s central bank is getting serious about controlling high inflation… that they had said was out of their control. The Bank of Canada (BoC) spent the past year claiming high inflation is due to external factors. A day after we explained to Parliament’s finance committee how monetary tools were used to create inflation, the BoC changed its mind. They reassured the public they will correct the high inflation with policy tools. Just to confirm, this is the inflation that couldn’t be addressed, since it was due to external factors? Got it.

The BoC Previously Claimed Inflation Was External and Transitory

The BoC has been pushing the transitory and supply chain narratives. Elevated inflation was just an illusion at first, due to the base effect. It would just go away in a few months. Then it was the supply chain. Constrained supply chains are resulting in low inventories, driving prices higher. These are external factors.

Monetary policy can’t address external factors. Raising interest rates with external inflation penalizes the economy, without reducing inflation. Higher rates can’t increase a factory’s output or make boats from China travel faster.

Canada Has An Excess Demand Problem, Not An Excess Supply Issue

Supply chain issues exist, but not to the extent they’re making them out to be — especially before Ukraine. As we explained last week, this isn’t a regular amount of demand failing to be met. This is excess demand for goods, far more than normal supply levels satisfy. The increased demand is the intended consequence of loose monetary policy. The BoC actively tried to create demand that outran supply, to create more inflation. 

Last October, the BoC was still using quantitative ease (QE). That’s important because annual CPI growth was double the target rate of interest at the time. QE is a monetary policy tool used to stimulate more demand (and inflation) when it’s low. Yes, the BoC was so committed to the belief inflation wasn’t real, they tried to make more while it was over 2x the target. 

If demand is running too hot due to monetary policy tools, they can control inflation. After all, the central bank’s only role is keeping inflation low and stable for the public.

BoC Pledges To Control Inflation They Said They Couldn’t Control

A strange coincidence happened a day after we explained the BoC’s policy tools to the finance committee. The BoC is suddenly able to address the issue of high inflation. They didn’t acknowledge their role, but now policy tools will be used to lower the rate to target.

“We have taken action and will continue to do so to return inflation to target, and we are prepared to act forcefully,” said BoC Deputy Governor Sharon Kozicki in a speech. “The Bank will use its monetary policy tools to return inflation to the 2% target and to keep inflation expectations well anchored.”

Once again, monetary policy can’t address supply chain related issues causing inflation. Rising rates in Ottawa don’t mean factories in Vietnam will produce more. Less QE doesn’t make avocados from Mexico grow faster. Higher interest rates only serve to slow demand back to normal, slowing inflation.

“I expect the pace and magnitude of interest rate increases and the start of QT to be active parts of our deliberations at our next decision in April,” the Deputy Governor said in the same speech.

The solution is to address the inflation tools they used over the past two years. Higher interest rates address the low rate credit stimulus driving home prices higher. QT reverses QE, the program driving more credit, supporting more demand and inflation. Weird way to increase inventories like lumber, but whatever works, right? It’s just weird to say it wouldn’t work a few weeks ago.

14 Comments

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  • Mark Bayly 8 months ago

    Real inflation is 15 per cent Not the trumped up inflation numbers by the government Raising interest rates to 2 per cent will not tackle inflation

    • Doomcouver 8 months ago

      Considering how indebted most Canadians are, it might actually help in a way as a debt-fueled asset collapse is definitely dis-inflationary. Definitely not the solution they’re shooting for, but I’m sure they’ll stumble into it eventually.

      • Mark Bayly 8 months ago

        Will happen because wages are far below inflation numbers and Canadians have the 2nd highest consumer debts in the world Vote Importing half a million immigrants every year means wages will stay low forever

  • Yoroshiku 8 months ago

    So there are 8 major components in the “basket of goods and services” that the gov’t uses to generate the CPI & inflation rates. One is “shelter” which is obviously the highest-weighted component. It’s just below 30% as a share of the basket. Given ever-rising housing prices, I’d really like to know if that number is accurate, since home prices have spiked nationwide since 2020. My neighbor is a suit at RBC and says it’s not unusual for people in the GTA to be spending 60-65% of their monthly gross income on mortgages. That does not seem healthy.

    I’m glad the Bank of Canada is going to finally raise interest rates. The artificially low interest rates have, as this site has pointed out many times, helped inflate the housing bubble.

    • Doomcouver 8 months ago

      The shelter component is based on average monthly shelter costs. So fixed-rate mortgages, and grandfathered rental rates depress the headline inflation rate temporarily. Ironically, higher interest rates will likely directly cause more inflation over the short term, as the variable rate mortgage sub-component of CPI will increase with rates.

      This also means that even if we end up mid-way through a nasty housing collapse, shelter CPI may still be rising as rents and variable rate mortgages will probably spike at the same time. It’s only after the impact of a price collapse is starting to be reflected in rentals and new mortgages that the headline inflation will begin to get pulled down, which probably won’t happen right away.

      • Trader Jim 8 months ago

        Don’t forget the contribution of imputed rent and interest rates. CPI pushed down the cost of shelter due to mortgage rates falling. It’s essentially counterweighted to never produce real inflation.

    • Retired Bricklayer 8 months ago

      This isn’t a brag, but when I went to buy, I found the amount of money the bank was willing to lend me was staggering. They were perfectly happy to see me put 50% of my after tax income into mortgage and property tax. I ended up borrowing just around 65% of the maximum they were willing to lend me (which already felt like a lot), but it took a lot of restraint — I passed on a lot of properties that the bank thought I could “afford” because the numbers just seemed crazy to me. And this was in the setting of record low interest rates.

      There’s just no way that cheap credit isn’t driving these insane prices.

  • Dave 8 months ago

    I think someone at BOC needs to study their micro and macro economics again. maybe they are outdated.

    • Doomcouver 8 months ago

      Maybe all the central bankers in the world collectively fell asleep in their ECON101 class while they were learning Keynesian economics. It’s like they only paid attention for the rate-cutting parts and not the rate-hiking parts.

  • Cowboy Junky 8 months ago

    Let me see
    With inflation I get a percentage of that in sales PST and GST.
    With higher interest rates i have to pay more on money on borrowed .
    All levels of Gov. are not stupid.
    Also 2 % interest hike might not kick start the fall of the housing market but add to it 15% inflation and you have the perfect storm . 2 % might have more effect on the stock market how much borrowed money is in it .
    Don’t worry when the money is lost into space the Gov will replace it with more
    Its all coming to a head

  • Gerald Moodie 8 months ago

    I do not believe that governments can tolerate any substantial increase in interest rates. In their foolishness of embracing modern monetary theory, deficits and debts have increased to a level that higher interest rates will cripple if not bankrupt them.

    I believe we’ll see a token rise in rates with a quick drop again as soon as the economy shows signs of slowing.

    I really feel sorry for younger generations who will be the ones that ultimately pay for this political irresponsibility.

  • Scott 8 months ago

    I think you surprised them. They thought nobody would notice…

    • Cowboy Junky 8 months ago

      It did go quiet . But the storm is coming .

  • Brian 8 months ago

    And fix your email subscribe button. No email get past your check 😂

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