Latest agreement leaves Bank of Canada’s responsibilities unclear
Through fits and starts, the Bank of Canada has evolved from the ambiguity and opacity of its early years to the greater transparency and accountability of today, particularly with respect to its objectives.
At the beginning, the bank lacked a clear objective because it’s mandate (the Preamble to the Bank of Canada Act) in the words of a former governor, said “a lot and rather little as the same time.” It offered neither guidance to the bank nor any basis for judging its actions. Nevertheless, it remained the bank’s guiding principle for over 60 years.
In the 1990s the federal government and the Bank of Canada reached an agreement that specified an inflation target of two per cent (with a band of one to three per cent), which effectively became the mandate to govern the bank’s monetary policy. It avoided the ambiguity of the Preamble by specifying a single objective that was measurable and had a specific timeframe for its achievement. The agreement has been renewed at five-year intervals ever since.
However, in preparation for the 2021 renewal, the bank considered alternatives to its approach to meeting the two per cent target including the so-called dual mandate (used by the U.S. Federal Reserve) that included maximum employment in addition to inflation, but found that the dual mandate weakened the public’s expectations of inflation and could derail the current framework because it lacked clarity with respect to weighting the two objectives.
As such, the 2021 agreement kept the two per cent inflation target while introducing a new element—that monetary policy should also support maximum “sustainable” employment. This element was introduced even though the bank conceded “it is not directly measurable and is determined largely by non-monetary factors that change over time.”
The statement goes into detail as how this objective would be achieved by using the flexibility of the one to three per cent range “only to an extent consistent with keeping medium-term expectations well anchored at 2 percent.” This strategy appears to be based on an unfounded belief that the bank can finetune monetary policy. Both recent and past experience, however, suggest that central banks have been slow to recognize and respond to the threat of inflation.
In reality, the 2021 change represents a watering down of the bank’s mandate by opening the door to a dual mandate in practise. Indeed, aside from the claim that the inflation target would remain the primary objective, the statement differs little from the way the Federal Reserve describes its dual mandate. The previous agreements were clear in providing both guidance to the bank and a basis for the government and the public to assess its performance. This clarity has been lost by adding a further objective, especially one that’s admittedly ill-defined and determined mainly by forces beyond the bank’s control.
The government has other weapons in its arsenal that deal directly with employment through the working of the labour market. The addition of maximum employment to the objectives of the Bank of Canada diffuses responsibility for the objective, leaving the ultimate responsibilities unclear. And the addition of maximum employment to the mandate may be costly by unjustifiably raising expectations for the bank that cannot be realized. Such a step may reduce the credibility the bank needs to achieve its prime objective of staying within the target inflation band.