Macklem keeping inflation expectations in check with call not to overreact, economists say

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Bank of Canada Governor Tiff Macklem is urging Canadians to resist overreacting to rising prices, asserting that a period of faster-than-usual inflation shouldn’t be seen as evidence that policy-makers are asleep at the switch.

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“You can be confident that we will keep the cost of living under control as the economy reopens,” Macklem wrote in the Financial Post on Thursday. “We shouldn’t overreact to these temporary price increases.”

The message was familiar. The governor made similar comments when he and his deputies opted on July 14 to keep the benchmark interest rate pinned near zero, despite new forecasts that show inflation will exceed the central bank’s target for at least the next couple of years.

Still, Macklem’s words were noteworthy because of the timing of their release and the way he went about communicating them to the public. The governor’s op-ed followed Statistics Canada’s announcement of new inflation data that showed the Consumer Price Index (CPI) rose 3.1 per cent in June from a year earlier, the third consecutive month that year-over-year increases exceed the high-end of the Bank of Canada’s comfort zone.

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Equally significant was the decision to take to the pages of a national newspaper to emphasize the central bank’s message that factors behind the current burst of inflation are mostly temporary. Concern about inflation has been growing since the beginning of the year, despite Macklem’s repeated assurances that the Bank of Canada is on the case. A commentary under his own name in a national publication had the potential to reach a large audience unfiltered.

“Governor Macklem is trying to remind people and manage expectations,” said Charles St-Arnaud, a former Wall Street economist who also worked at the central bank in the early aughts. “By doing it through a newspaper, (he) can reach a broader audience,” added St-Arnaud, who is now the chief economist at Alberta Central.

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Inflation has been climbing steadily since January. The annual increases in the CPI accelerated past three per cent for the first time since the start of the COVID-19 crisis in April, and then surged to 3.6 per cent in May, the fastest in a decade. The Bank of Canada insisted that the increases were being exaggerated by comparisons to the spring of 2020, when the inflationary trend was closer to zero.

But those explanations might not satisfy households and executives who are shocked by how much they are paying for goods and services now. Macklem could be trying to temper such concerns before they turn into a “self-fulfilling prophecy” and consumers and businesses alike begin to factor higher inflation into their budgets, said Steve Ambler, the David Dodge Chair in Monetary Policy at C.D. Howe Institute, a Toronto-based think-tank.

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In the July Monetary Policy Report, a quarterly publication wherein policy-makers outline their economic forecasts, Macklem and his deputies said they expect inflation to continue running above the target range, predicting annual increases in the CPI would average 3.9 per cent over the third quarter. Policy-makers listed a number of factors contributing to high prices — which Macklem restated in his op-ed — including supply-chain disruptions, productivity reductions and commodity booms.

“Inflation should move back inside our target range next year as businesses work through these temporary factors and the people who lost their jobs during the pandemic rejoin the workforce,” Macklem wrote in the Financial Post.

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However, the term temporary leaves room for uncertainty, said Ambler, as the Bank of Canada has opted against providing a definition. The central bank’s current forecast expects inflation to begin settling next year, before accelerating again in 2023, and then stabilizing around two per cent in 2024.

If the faith in the central bank wavers, firms can begin to factor inflation into their prices and employees can begin demanding higher wages for the rising cost of living. “What happens to inflation depends partly on inflation expectations,” said Ambler.

While Macklem insists that the drivers of inflation are most likely transitory, “there are lots of signs that it could be more than temporary,” said Ambler, citing the growth in money supply, pent-up demand pushing up prices and months- and years-long bottlenecks, like the chip shortage which isn’t expected to end until at least next year.

Both St-Arnaud and Ambler said the Bank of Canada will pay close attention to consumer and business expectations, likely through their quarterly assessments of those sentiments, to prevent that self-fulfilling prophecy and runaway inflation.

“The pandemic has taken lives and livelihoods and pummelled our economy,” Macklem stated. “The Bank of Canada was there to prevent deflation when the economy plunged. We remain just as determined to secure a complete recovery and keep inflation under control.”