In inflation fight, nice guys finish last
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Bank of Canada Governor Tiff Macklem has more or less cornered himself into resuming the rapid escalation of interest rates that he started last year and suspended in January this year. The purpose of raising rates would be to curtail inflation, but it is far from clear how much success Macklem’s stop-and-go method will achieve.
Statistics Canada reported last week that the Consumer Price Index in April rose 4.4 per cent over the course of the preceding year. The year-over-year increase in March had been 4.3 per cent. The April figure was the first acceleration in consumer inflation since June 2022.
Macklem and his colleagues at the Canadian central bank raised interest rates at every opportunity from March 2022 until January this year, when he decreed a pause in rate increases to await developments. Central banks of other leading industrial economies, meanwhile, continued raising rates because they had not yet seen signs that inflation was easing.
Canada’s inflation did indeed decline to an annual rate of 4.3 per cent in March from its peak of 8.1 per cent last June. The governor, however, was finding it harder than he expected to bring inflation all the way down to the bank’s target level of two per cent per year. He started warning the public that if workers didn’t moderate their wage demands and companies didn’t start curbing their appetites for price increases, he was going to have to swing the interest rate hammer once again.
As though calling his bluff, the Consumer Price Index rose faster in April than in March. In these circumstances, the governor must raise rates or risk looking like a fool.
His new problem, however, is that Canadians have noticed his hesitancy.
They have started assuming that the bank has lost its nerve, that it will reach for soft options and go out of its way to avoid the nastiness of a bank-generated recession.
They (Canadians) have started assuming that the bank has lost its nerve, that it will reach for soft options and go out of its way to avoid the nastiness of a bank-generated recession.
The classic way to curtail inflation is to raise interest rates so high that families are driven out of their homes, workers lose their jobs, firms go out of business and economic growth shifts into reverse. Canada lived through such a period in the 1980s, and it was not a pretty sight. It did, however, eventually end inflation and restore the price stability that Canadians enjoyed until last year.
While Canada’s central bankers have been backing and filling, the United States Federal Reserve has taken a very different approach. Chairman Jerome Powell over the last year has missed no opportunity to say that the U.S. central bank must stay firm and resolute in driving up interest rates even if the results are extremely painful for some families and some businesses.
Despite the Fed’s steely resolve, U.S. consumer prices in April showed a sudden acceleration. The index rose by 0.4 per cent in April after rising 0.1 per cent in March. To that extent, the kinder, gentler method of the Bank of Canada and the ruthless, brutal method of the U.S. Federal Reserve produced remarkably similar results. Play nice? The prices rise. Play tough-guy? Prices rise pretty much the same.
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Many Canadians are likely to conclude that the central bankers don’t actually know how to restore price stability.
Once that belief becomes widespread in the economy, Macklem and his colleagues will face the added problem of raised inflation expectations.
Canadians will take it for granted that prices and wages will be higher next year and they will automatically write that assumption into their wage negotiations and the acceptance of price hikes.
Everyone now knows that Tiff Macklem wants to be a nice guy, and in the race to curb inflation, it’s not hard to see where nice guys finish.
