Inflation and inequality: How the Bank of Canada’s policies missed the mark

Inflation and inequality: How the Bank of Canada’s policies missed the mark


Opinion: The blunt instrument of interest rate hikes added to economic woes of Canadians

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By DT Cochrane

The Bank of Canada has announced its fourth interest rate cut in a row and says that high rates successfully tamed inflation. But does the central bank really deserve the credit? Short answer: no.

The Bank of Canada currently has a single mandate: manage inflation. It has a single tool to do so: the policy rate. As a result, the central bank did the only thing it could do when inflation began to rise in early 2021: it raised rates. But this was never the right tool for the inflation we had.

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The theory behind interest rates and inflation management is that higher rates reduce demand, which lowers the upward pressure on prices. In other words, interest rates are a demand-side response. But the inflation that began in 2021, and remained elevated for the next two years, was not caused by so-called excess demand. It was caused by turbulent supply and compounded by corporate profiteering.

The biggest disruption to supply was obviously COVID-19. Other factors included Russia’s invasion of Ukraine and natural disasters such as the 2022 flooding in British Columbia. These events raised costs for producers and shippers. Eventually, those higher costs made their way to consumers.

But Canadian families were not simply paying more because the costs of production increased. Many corporations took advantage of the economic turmoil to boost their profit margins, which caused prices to rise even more. Higher interest rates were not going to resolve supply issues or lower profit margins. Inflation in Canada has now slowed because global supply problems were resolved. Note, however, that profit margins remain elevated.

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Although the Bank of Canada should not take credit for lowering inflation, it does deserve blame for adding to other economic woes, especially higher housing costs and worsening inequality.

The rate of inflation has been below three per cent since the beginning of the year and below two per cent since August. But rent continues to climb by more than eight per cent. The last time Canadians experienced rental inflation this high was the early 1980s.

Rising rents are due, in part, to higher interest rates. This obviously hits lower-income households the hardest. But this is just one of the ways that higher rates hurt poorer families more than wealthier ones.

According to a recent report by the Parliamentary Budget Officer, inflation eroded the purchasing power of all households. To add insult to injury, higher interest rates caused further erosion for the bottom 80 per cent of the income distribution, but gains for the top 20 per cent. In other words, the rate hikes transferred income from poorer households to wealthier ones.

Higher interest rates are also driving up unemployment. Before the pandemic, Canada’s unemployment rate dropped to record lows. The rate is now more than one percentage point higher than that laudable achievement. That is more than 200,000 extra people without work. Even worse, falling labour force participation suggests growing discouragement, especially among young people.

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In the Bank of Canada’s defence, given its single mandate and its single tool, it essentially had no choice but to hike rates. That said, it did not need to hike them as sharply or leave them elevated for so long.

However, the real blame falls on successive federal governments that have largely abdicated their responsibility in managing prices and curbing corporate profiteering, leaving the Bank of Canada to rely on blunt tools such as interest rate hikes, which were never suited to the inflation we faced.

Some of the causes of the recent bout of inflation were entirely predictable, including corporate profiteering. The federal government could have used other tools to ensure prices did not spiral out of control. For example, a windfall profit tax would have reduced profiteering and returned those ill-gotten excess profits to public control.

The federal government cannot leave inflation management entirely to the Bank of Canada. At the same time, inflation should not be the central bank’s sole mandate. The United States Federal Reserve has a dual mandate to stabilize prices and maximize employment. Canada should adopt the same.

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The idea that the responsibility for inflation and employment could be neatly divided between the Bank of Canada and the government needs to be rejected. Monetary and fiscal policy have to work together.

While interest rates have a role to play in economic governance and price stabilization, they cannot be the only tool.

DT Cochrane is a senior economist at the Canadian Labour Congress.

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