Tiff Macklem’s legacy will be defined by whether he leaves the central bank better equipped to confront future crises
Published Jan 16, 2023 • Last updated 20 hours ago • 4 minute read
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Bank of Canada Governor Tiff Macklem. Photo by Jennifer Gauthier/Reuters files Some would fire Tiff Macklem as Bank of Canada governor for missing the inflation surge. If he was the only one to have misjudged, then that impulse would have merit. A better standard might be how he performs from here, with emphasis on what he learns from his mistake. Macklem’s legacy will be defined by how much pain is caused by his aggressive interest rate increases and whether he leaves the central bank better equipped to confront future crises.
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The former will be the story of 2023. When asked whether Canada could avoid a recession this year, only one person in a room of about 200 people at the Canadian Club’s annual outlook lunch in Toronto on Jan. 11 raised their hand. Yet investors are starting to wonder if the “soft landing” that central banks promised — without something less than full conviction — might actually be possible. Canadian employers created more than 100,000 jobs in December, and the unemployment rate dropped to five per cent, despite the most aggressive series of interest rate increases in the Bank of Canada’s history. Maybe Macklem knows what he’s doing.
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Stopping inflation might be the easier challenge. Humans are poor at both admitting mistakes and opening our minds to information that contradicts our world view. Charles Darwin used to make a point of taking notes on new information that contradicted his understanding of things because “such facts and thoughts were far more apt to escape from memory than favourable ones.” That’s what it took to come up with the theory of evolution. Central bankers must be equally rigorous in their post-mortems of what went wrong during the pandemic. Some of the criticism of their performances is overdone, but it’s obvious they don’t have as good a read on how the economy works as they thought they did.
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The Bank of Canada has begun making amends. Macklem acknowledged in front of legislators in April that the institution botched its inflation forecast, which meant it was slow to respond when inflation jumped out of the central bank’s comfort zone in the spring of 2021. “We’re not getting it perfect,” Carolyn Rogers, the senior deputy governor, said a few weeks later, observing in an interview that the central bank’s models weren’t designed to deal with the complex aftermath of a pandemic, a war in Europe and China’s draconian COVID-19 lockdowns.
But the central bank has been reluctant to go deeper than that. In July, when they released their latest quarterly economic outlook, policymakers attached an appendix on the “main factors behind inflation forecast errors” that was more of an accounting exercise than a mea culpa. Macklem finally approached something like introspection at the end of 2022, using his final speech of the year to share three lessons from the inflation mistake: supply shocks like the one that came with the COVID recovery are harder to manage than demand shocks; inflation models failed because they were overly reliant on averages, which allowed falling prices for services to obscure surging prices for goods; and suppliers are quicker to add rising input costs to retail prices when inflation is hot, apparently because buyers (temporarily, at least) are prepared to pay whatever it takes when the cost of everything is rising.
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“Our experience in 2022 is that surprises can combine and interact with each other, resulting in outsized effects on inflation,” Macklem said.
It’s a start, but the Bank of Canada can go deeper. This week, Beata Caranci, chief economist at Toronto-Dominion Bank, published a paper on where she thinks the central bank went wrong. Caranci wondered why central bankers were blind to signals that typically would have caused them to raise interest rates. A decade earlier, monetary policymakers bemoaned how finance ministries abandoned them during the painfully slow recovery from the Great Recession. The fiscal response to the COVID crisis was unprecedented, yet instead of taking a step back, central banks went all-in. Why?
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Recommended from Editorial Interest rates headed higher after Canada’s job gains blow past expectations Kevin Carmichael: Tiff Macklem made some mistakes, but at least he’s not hiding from them Tiff Macklem reflects on debt, lessons learned and why inflation ‘messes up’ competition Caranci thinks the Bank of Canada was trapped in a mental prison of its own making. “They relied too much on past observations, rooted in a set of heuristics or rules that prevented the evolution of thought,” she wrote. “Simply put, the Bank of Canada was overly biased to ‘what was’ rather than ‘what is.’”
Between the fall of 2017 and the release of its updated policy mandate in December 2021, the Bank of Canada devoted considerable intellectual energy on whether targeting inflation was still the best way to achieve price stability. That work was conducted under the assumption that disinflation would be the bigger worry in the future, not inflation. Policymakers spent four years worrying about economic growth. The prospect of higher interest rates and persistent inflation was a forgotten problem.
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Article content “This entrenched a mindset that playing it safe meant erring on the side of leaving interest rates at emergency levels, irrespective of the evolution of the data,” Caranci said. “The burden of proof required the data to not just convince the central bank that it would succeed in its inflation mandate, but to erase every millimetre of doubt.”
The Bank of Canada might now have flipped, as Macklem has been clear he will err on the side of crushing inflation, even if that means causing a recession. Maybe that means we’re about to replace an era of placidity with one of constant volatility, as central bankers jump from dousing inflationary fires to trying to reignite them.
Surely we can do better than that, but discovering whether that’s true might require central banks to be more like Charles Darwin. “Hindsight is a great instructor but not a practical tool in the moment,” Caranci said in her paper. “Better to focus the lens on avoiding bias that anchors to past dynamics (which) blind us to current developments.”
• Email: kcarmichael@postmedia.com | Twitter: carmichaelkevin