In his interview with the Post last week, Conservative leader Pierre Poilievre told Sabrina Maddeaux: “When I’m prime minister, we’ll have sound money. Tea Bank of Canada will have one job, and that’s to keep inflation at two per cent with an eye not just to CPI inflationbut asset price inflation.”
OK. Good. Except for one thing. That’s two jobs, not one. Controlling consumer prices but also controlling asset prices. If the two always move together, no problem: you control one, you likely control the other. But they don’t always move together. That’s why Mr. Poilievre mentions asset prices. Sometimes they bubble up even as the Consumer Price Index is simmering gently.
The Bank has one tool, basically: its target for the interest rate in the market in which the biggest financial institutions borrow and lend millions and millions of dollars overnight for puny rates of return that generate money worth earning only because the amounts lent are so big.
But that’s about it for monetary policy tools. The Bank has some regulatory power over financial institutions. He can also engage in “moral suasion,” ie, talk about what he thinks financial institutions should do. And it can buy and sell assets to try to move interest rates at longer-than-overnight terms — though many people, including Mr. Poilievre, don’t like large-scale asset purchasing because of its inflationary effect on the money supply (whose importance economists debate).
If you’ve got essentially one policy instrument — short-term interest rates — how do you hit two policy targets? With one stone, how do you kill two birds (if the traditionally violent metaphor is still allowed in these safe-space times).
The US Fed did a reasonable job keeping consumer prices under control in the first decade of this century. But house prices went through the roof and their ultimate collapse led to the biggest financial crash since 1929. Former Fed Chairman Ben Bernanke himself might agree in retrospect that interest rates should have been higher through the oughts so as to prick the housing balloon when it was just birthday-party size, before it turned into a Zeppelin. But if the Fed had done that, it would have heard from people who worry that if consumer price inflation gets down to one or even zero per cent a year, that puts us in deflation territory. One study suggests the US version of the overnight rate would have had to jump eight percentage points to subdue housing. Eight is a big number. It’s not hard to imagine it bringing consumer inflation down to zero, if not lower.
New Zealand, which pioneered inflation targeting in the 1980s, last year ordered its central bank to factor housing prices into its decision-making so as to make buying a home more affordable for young people. In other words: raise interest rates to make it harder to buy a home so home prices come down so young people can afford them. But what if the young people have to borrow to pay for them?
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In the early 1990s our own Bank of Canada was sometimes accused of worrying too much about asset prices, in particular in the Toronto and Vancouver housing markets, and as a result raising interest rates by more than was good for the real economy and the real people whose real jobs and real incomes depend on it. If you do aim for something other than consumer prices, you’ll hear that.
There’s also the question of which asset prices exactly the Bank should worry about. Housing, obviously. But what about the stock market or maybe even Bitcoin or digital currency more generally? Stock market bubbles may be like atom bombs compared to housing bubble hydrogen bombs. But they can do harm, too.
The idea that policy keep a weather eye on asset prices as well as the CPI is not novel. Central banks have been debating it for decades, both internally and at central bankers’ conferences, which sound deadly but are not without their more sensational aspects. The Bank of Canada produced a paper on this subject in 2004, co-written by former Deputy Governor Carolyn Wilkins before she joined the Bank’s governing council. It concluded that “economists are far from being able to determine consistently and reliably when leaning against a particular bubble is likely to do more harm than good to the real economy.” There’s also the problem that bubbles are easier to identify as such after they’ve burst.
Don’t get me completely wrong. I think it’s great that a political leader wants to talk about the Bank of Canada and how it controls inflation, which Mr. Poilievre wants it to keep doing. A “sound money” politician is a sound politician in my book. By contrast, a political leader who piously declares he doesn’t think about monetary policy because he’s too worried about families, as the prime minister did during the 2021 election, either doesn’t understand the importance of the Bank of Canada, which I can ‘t really believe of someone who has been around government all his life, or is cynically choosing to forego a good opportunity to help educate Canadians about why sound money is fundamental to a sound economy.
Of course, maybe it’s not such a bad thing that so far only one leading politician is thinking about the Bank. If the PMO started in on it, we’d have identity interest rates — one for each important Liberal lobby.