The Bank of Canada has seen what happens when inflation goes unchecked

(Ottawa) Canadians are seeing borrowing costs soar as the Bank of Canada takes historic steps to curb soaring prices after learning costly lessons from history when central banks let inflation run wild.

Posted at 7:11 am

Nojoud Al Mallees
The Canadian Press

The Bank of Canada recently hiked its policy rate by a full percentage point – the largest single hike in more than two decades – as it seeks to cool domestic demand and lower inflation expectations.

An unusual decision for an unusual time: annual inflation hit 8.1% in June, a 39-year high after years of stable and predictable CPI in Canada.

But for most of the 20th century, price stability in Canada’s economy was not a matter of course.

TD Bank chief economist Beata Caranci pointed out that inflation may seem particularly difficult today because Canadians have been sheltered from its volatility for decades.

“We haven’t had that challenge in a while,” noted M.me Exhausted.

A “significantly different” approach

Canada’s last experience of high inflation came in two waves in the 1970s and 1980s, notably peaking in 1981 at 12.9%.

In 1973, adverse weather conditions led to global food shortages, and an Organization of the Petroleum Exporting Countries (OPEC) oil embargo drove up energy prices. A few years later, a second energy crisis was caused by the 1979 Iranian revolution.

And even if the drivers of high inflation remain relatively similar — global circumstances that are pushing up food and energy prices — current inflation is unlikely to be as high or as persistent.

That’s because central banks’ approach has now changed significantly, explained Stephen Williamson, a professor of economics at Western University.

“One big difference is that there’s now a kind of ingrained notion that the Bank of Canada’s primary job is to control inflation,” Williamson said. That wasn’t true in the 1970s. »

For most of the 20th century, central banks had yet to develop strong and effective mandates to maintain a stable inflation gauge, Williamson continued. Instead, they tried to control inflation through the money supply.

Economists at the time believed that inflation could be managed by controlling the amount of money circulating in the economy. However, central banks have found this tactic unsuccessful.

Mme Caranci explained that if the Bank of Canada has been slow to intervene this time around, it was partly because central banks have always been reluctant to stifle economic growth by raising interest rates.

TD Bank economist James Orlando wrote an analysis in April comparing today’s high inflation to that of the 1970s and late 1980s.

“Inflation expectations were revised upwards, leading to even higher inflation in subsequent years,” Orlando said.

Interest rates eventually reached 21% in the 1980s.

Several differences in the game from one era to another

In 1982, the Bank of Canada announced that it would no longer target the money supply and instead focus on interest rates.

Canada’s turbulent experience of high inflation also prompted the Bank of Canada’s mandate to maintain a target for rising prices. In 1991, the Bank of Canada and the Secretary of the Treasury agreed on an inflation control framework to guide monetary policy.

“We believe the Bank of Canada has learned a lesson from history,” Orlando wrote in his comparison of inflation over the two eras.

This time, Canada’s central bank is still under fire for taking too long to start raising interest rates. By comparison, however, the Bank of Canada has acted faster and more forcefully than in the past.

“Today we hear a different discourse from the central bank, according to which there is a will to sacrifice growth and even increase the unemployment rate,” emphasized Dr.me Exhausted.

In its recent interest rate announcement on July 13, the central bank sent a clear message: it is not afraid to act aggressively to curb rising inflation.

At the same time, economists like David MacDonald of the Canadian Center for Policy Alternatives use history to warn that raising rates too quickly could trigger a recession, as happened in the 1980s.

However Mme Caranci said there were significant differences between the two periods, including a different composition of the economy and the existence of safeguards such as mortgage stress tests.

“The difficulty with making comparisons between periods, especially when you go that far back in history, is that there are multiple differences at play,” explained M.me Exhausted.

In May, Toni Gravelle, deputy governor of the Bank of Canada, gave a speech stressing why comparisons between stagflation in the 1970s and the current inflationary environment are “unfair”. In particular, he mentioned strong economic growth, a tight labor market and historically low unemployment.

Most importantly, Mr Gravelle pointed out that today’s Bank of Canada has the policy tools it needs to control inflation.

“Since the 1990s, the Bank of Canada and other central banks have had success targeting inflation,” he said. In Canada, inflation has been relatively stable and close to 2% for almost 30 years. And we are determined to get it back on track with rate hikes and clear communication. »

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