Wednesday, 9 March 2011

Inflation Control Debate Underway in Canada: Why We Need to Pay Attention

Inflation is one of those things where most often the best a citizen or investor can do is not lose ground. Whether it is a salary that does not keep up with rising expenses (just today, Canadian Capitalist was justifiably moaning about huge increases in home insurance premiums) or GIC rates that do not compensate for inflation even before taxes, we always seem to be one step behind or losing ground. The problem is especially acute for retired people where normal annuities are not indexed and a pot of money must suffice for ever longer life expectancy.

That there should be inflation is government policy. The target, characterized as "low inflation", is currently at 2% and allowed to vary within a 1 to 3% range according to the organization mandated to make sure that happens, the Bank of Canada.

Right now, the debate about how much inflation is to be created or allowed is wide open. The reason is that the five-year agreement between the federal Minister of Finance and the Bank of Canada on the target and the system to measure or control inflation expires at the end of 2011.

The most visible part of the debate, though no doubt there is lots going on behind closed doors at the Bank of Canada and the Ministry of Finance, and invisible to us ordinary schmucks, seems to be emanating from the CD Howe Institute in a series of reports. The main issues and/or suggestions include whether to:
  • lower the target rate for CPI increases from 2% to 1.5%, 1.4% or even 1%, about which I ask, why not a zero percent inflation target?
  • replace inflation targeting, which we have now, with price level targeting; "The key distinguishing feature of price- level targeting is that shocks pushing the price level off its intended growth path must be recouped, meaning that a temporary rise in inflation above 2 percent must at some point be offset by future inflation of less than 2 percent. In contrast, with inflation targeting, the same positive inflation shock is subsequently reversed, but not recouped: for the price level, bygones are bygones." (from Precision Targeting: The Economics – and Politics – of Improving Canada’s Inflation-Targeting Framework by Christopher Ragan at CD Howe). In other words, with price level targeting, we don't have a permanent loss of purchasing power that we somehow have to try to recoup on our own under inflation targeting. Why not let the Bank of Canada do the job for everyone through price level targeting?
  • mandate the Bank of Canada to include control of asset price bubbles as one of its objectives in setting monetary policy. That goal does not form part of its mandate right now. Why not have the BOC prevent asset bubbles? In the last ten years we've had the painful High-Tech stock bubble and the USA/European housing bubble. Though the housing bubble that caused the 2008 crash wasn't in Canada and thus would not have spurred BOC action, would not such a policy be worth it for all central banks? Would it not have been less painful to avoid the big crashes? No doubt there would be costs and possible downsides but maybe they are less than the damage of recurring asset crashes. Authors like Robert Barbera in The Cost of Capitalism (my review here) make a reasonable case for central bank control of bubbles.
Do a Google search of the phrase "too important to be left to the experts" and you will find it popping up in any number of contexts - health care, finance, biotechnology, war, science and in general. If we don't say something, inflation will surely be done to us for "our own good" though we may not like the result.

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