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.