Monetary policy matters tremendously in real life and in the labour market. It affects the day-to-day life of individual Canadians and businesses and may continue to impact their income streams for a long time. Monetary policy also affects productivity, the future potential of the economy and the distribution of income.
As the Bank of Canada and the Government of Canada gear up to renew their five-year agreement on the central bank’s monetary policy framework, I remain convinced that the so-called “dual mandate” — targeting both inflation and full employment — is the right option for the next phase of monetary policy. Let me explain why.
First, the dual mandate is the only option that takes into consideration Canada’s present economic situation. This monetary policy can therefore play an active role in the economy’s recovery from the COVID-19 pandemic, while simultaneously keeping an eye on inflation.
Canada is in a totally different economic environment in 2021 than it was 30 years ago, when the central bank and the federal government first struck an agreement on monetary policy. Each version of that agreement has respected basically the same objective: price stability. However, inflation today doesn’t pose the same threat it used to. While some may fear inflationary pressures in the near future, the Bank of Canada does not share the view this will be a serious problem in the medium term.
Due to globalization, technological changes and many other factors, price increases have, on average, been relatively low since the 1990s. Apart from the years immediately preceding the pandemic, when demographic factors such as aging produced labour shortages in some provinces and sectors, Canada’s main problem has been unemployment. The crisis of unemployment is now back at the forefront of public policy debates and monetary policy must acknowledge this reality.
Second, the dual mandate presents itself as the most credible option amongst the frameworks the Bank of Canada is considering, the other three being: nominal GDP targeting, increasing the target of inflation or the status quo. The credibility of monetary policy depends, in part, on people’s understanding and expectation of what the policy will achieve.
For this reason, the option of nominal GDP targeting should be discarded. Even though it incorporates issues that relate to the present economic situation — including employment — it is somewhat difficult to explain and fails the credibility test.
The option to increase the inflation target also covers employment, but it, too, fails the credibility test. Indeed, how can one explain to the public that the economy needs more inflation when Canada’s central bank has argued for so many years that the economy needs fairly moderate price increases? This option is neither easy to argue nor to communicate.
What about the status quo? I’m convinced the status quo is not an option because it focuses only on inflation targeting, when the main problems we face concern growth and employment.
The choice, then, becomes obvious. It is time for Canada to adopt a new and expanded framework for its monetary policy that embraces not only price stability, but full (or maximum) employment, as seen in countries like the United States, Australia and New Zealand. In short, it is time the Bank of Canada adopts the dual mandate.
As Quebec economist and university professor Pierre Fortin has often argued, the dual mandate adopted in the U.S. may explain why the American unemployment rate has often been lower than the Canadian one.
The dual mandate is a more credible choice for the coming decades, especially given the challenges that lie ahead, such as increased risks associated with climate change and technological advancements, among others. It’s also a more credible option because it’s more equitable; it considers the concerns of those who have assets as well as those whose livelihoods depend on steady work.
Furthermore, I would argue that the dual mandate is more efficient. By taking employment into account, it could indirectly have positive effects on productivity, which in turn could help absorb increases in supply costs.
The dual mandate may demand more coordination between monetary and fiscal policies, but that is not an absolute constraint. Indeed, the Bank of Canada and Finance Canada already collaborate regularly.
It’s time for the Bank of Canada and the Government of Canada to choose a monetary policy that reflects today’s economic environment. The dual mandate is the best way to grow Canada’s economic potential — now and in the future.
Senator Diane Bellemare represents the Alma division of Quebec in the Senate.
This article was adapted from a paper written for and presented at a conference on the future of Canadian monetary policy held by the Max Bell School of Public Policy at McGill University from September 22-25, 2020.