Making decisions in the vault

The Bank of Canada’s current five-year mandate ends this year. Providing the bank with a new mandate is probably the single most important decision that Finance Minister Bill Morneau will have to make in this job, but from what I can tell, the fix is already in. Whatever debate there might have been, has already taken place within the walls of the Bank of Canada and the matter has been decided. The next mandate will essentially be the same as the existing two per cent inflation target, with perhaps some additional language about the importance of financial market stability.

This may be a good idea; i t may even be the best choice. But the fact that this decision has already been made without public input — or, indeed, without public knowledge — is troubling. Policy- making in a democracy should not consist of unelected officials presenting the rest of us with a fait accompli.

It’s not easy to reconcile democracy with sensible monetary policy. Since so much of monetary economics is forward- looking, what monetary authorities actually do on a given day is usually less important than what people expect them to do over the next few years. As a result, much of Canada’s monetary policy framework is focused on establishing and maintaining the credibility of the Bank of Canada.

This is hard to do when monetary policy is conducted by politicians. Since the government of the day has many goals — getting reelected not the least of them — it can’t always be counted on to carry out its promises: everyone knows that other, more pressing priorities may take precedence over monetary policy. And it’s not even enough to simply deliver on its commitments. If a government announcement to adopt a contractionary policy stance is not seen as credible, then actually following through on the promise can prove costly. ( This is the lesson we learned during the recession of 1981- 82, which for Canada was even more severe than the global financial crisis of 2008- 09.)

One solution is to simply take the politicians out of the picture. If the monetary authority is removed from the competing priorities of elected governments, it will be easier to make commitments that will be believed. Monetary policy is more effective at achieving its goals, if it is conducted by experts who are freed from the compromises of electoral politics. But what should the central bank be aiming to achieve? In a democracy, determining the goals of public policy isn’t a responsibility that can be delegated to technocrats.

Canada’s system of monetary policy mandates was set up to resolve this tension. Responsibility for monetary policy ultimately lies with the minister of finance; this responsibility is discharged by providing the Bank of Canada with a formal mandate. This way, policy goals are set by the elected government, but once the mandate is set, the governor of the Bank of Canada has the authority to carry it out without government interference. This operational autonomy makes it easier for the Bank of Canada to make the sort of credible commit- ments over the short and medium term that it needs to be effective. This system has worked fairly well for the past 20 years: the inflationtargeting mandate kept getting renewed and there was little reason to change it.

But things are different this time around. For one thing, the Bank of Canada has not had the sort of success in controlling inflation that it has enjoyed in previous mandates. For another, inflation targeting no longer enjoys the broad support it once had among policy analysts. Many have argued, both within and outside the bank, that instead of targeting the rate of growth of the consumer price index ( i. e., the rate of inflation), the bank should target its level, so that past deviations from the target would be corrected, instead of forgotten. Others have argued that the bank should target nominal gross domestic product instead of the price level. One of the advantages of targeting a level, instead of a growth rate, is that it obliges the bank to act more aggressively, making recessions less severe. There is a real debate to be had here.

Each November, the Bank of Canada holds a private, invitation- only confer-ence, and last November’s theme was the renewal of the bank’s mandate. I was glad to be invited, because I thought I was going to see some of these arguments thrashed out. I quickly learned that the level targeting option was not going to be discussed at the conference, and the only explanation I got was from a bank official that I managed to buttonhole by the coffee station.

I wish I could tell you what he said, or what the other people at the conference said, but I can’t. I offered to write about the discussion using Chatham House rules (repeating what was said, but without identifying the speakers), but even that was considered to be too much of a breach of confidentiality. I’m pretty sure that level targeting will not be adopted in the next Bank of Canada mandate, but we’ll never know the story of how or why that decision was made.

As things stand now, the fundamental goals of Canada’s monetary policy are set behind multiple layers of secrecy and then rubberstamped at the last minute. After the events in the U. K. last week, I’m worried about the long- term sustainability of this sort of arrangement.

THE FUNDAMENTAL GOALS OF CANADA’S MONETARY POLICY ARE SET BEHIND MULTIPLE LAYERS OF SECRECY AND THEN RUBBER-STAMPED AT THE LAST MINUTE.