The Bank of Canada will maintain its 2% inflation target for the next five years, but has formally been given license to moderately overshoot it to “support maximum sustainable employment.”
In a mandate renewal released jointly with the Canadian government on Monday, the central bank added a new requirement whereby officials will use its 1% to 3% control range to “continue” supporting employment levels if warranted, while emphasizing the primacy of targeting inflation.
The renewal puts more weight on the inflation range than has been the case in past statements and explicitly introduces the need to consider the labor market. But officials made that objective less important for monetary policy than price stability.
The government and the bank “agree that monetary policy should continue to support maximum sustainable employment, recognizing that maximum sustainable employment is not directly measurable and is determined largely by non-monetary factors that can change through time,” according to the joint statement.
“Further,” it said, “the government and the bank agree that because well-anchored inflation expectations are critical to achieving both price stability and maximum sustainable employment, the primary objective of monetary policy is to maintain low, stable inflation over time.”
The statement was largely in line with what many economists had been expecting — a formalization of what was already implicit in the Bank of Canada’s previous mandates. While the central bank had studied the benefits of a major overhaul of the mandate, any arguments in favor of a big change were weakened as inflation accelerated in recent months.
In past mandates, “it was just more implicit and vague, but well understood by Bank of Canada watchers,” Jimmy Jean, chief economist at Dejardins Securities, said by email. “Now they’re choosing to make it explicit, perhaps to stress the importance of the labor market” in situations where the economy is not at full employment.
Canadian inflation has been above the upper limit of the central bank’s control range for seven months, and is currently hovering at a two-decade high 4.7%. The Canadian dollar was little changed after the statement, trading down 0.5% from yesterday at CA$1.2794 per U.S. dollar at 10:25 a.m. in Toronto. Yields on Canadian government two-year bonds fell 4 basis points to 0.934%.
Since the 1990s, the bank has been narrowly focused on a single objective: to keep prices stable. The goal has been to keep inflation within a range of 1% to 3% as much as possible. Operationally, that’s meant aiming for a 2% target over the Bank of Canada’s forecast horizon, a period of about two years.
The statement provided some details into how the new mandate would work. It will use flexibility of the range “when conditions warrant” with officials promising more transparency in how they plan to use it. According to the statement, the bank will explain when it is using the flexibility and will report on how labor market outcomes have factored into decisions.
The statement also said policy makers will use that flexibility “only to an extent that is consistent with keeping medium-term inflation expectations well anchored to 2%.” There’s also a reference to the central bank using a “broad set of tools” to address challenges of structurally low interest rates, including maintaining low borrowing costs for longer.
The document is much more extensive than the last one in 2016, with references to climate change, the pandemic, and the need for more inclusivity in the economy. There was a recognition the Bank of Canada is “well-equipped to address some of these challenges, less so for others.”
Another addition to the statement was a reference that the Canadian government sharing responsibility for achieving the inflation target and maximum sustainable employment.
The statement also acknowledged a low interest rate environment can fuel financial imbalances, with the government pledging to working with federal agencies to deal with the risks if needed.