Bank of Canada Governor Tiff Macklem launched the central bank’s review of its framework, but strongly suggested that officials are likely to re-endorse the bank’s current approach to targeting two per cent inflation.
“Now is not the time to question the anchor that has proven so effective in achieving price stability,” Macklem said in prepared remarks of a speech in the Toronto area on Friday, marking the first time since 1995 that the bank has closed the door on rethinking the 2% target.
Instead, Macklem said the central bank needs to focus its resources “on the most pressing and important issues” for the framework, including looking at a “richer” playbook for handling supply shocks to the economy.
Importantly, Macklem said the bank would look at whether the central bank’s preferred core inflation gauges — currently the so-called trim and median measures — remain appropriate “in a world with more volatility.” He said the bank will focus on whether it should adopt a “broader” approach to underlying inflation metrics, and examine their robustness.
Macklem also acknowledged that the bank may need to pay more attention to Canada’s housing market as it sets policy, and whether higher shelter price increases are distorting core measures.
“We must consider how monetary policy affects housing demand and supply and how the imbalance between them feeds into inflation in shelter prices,” he said.
The Bank of Canada’s framework is reviewed and renewed periodically, now every half-decade. Each time, officials have re-adopted the 2% inflation targeting approach with relatively minor adjustments. Still, the bank had at least floated alternatives, including price level targeting and nominal GDP targeting, during previous reassessments.
Trump tariff impacts
Macklem also laid out a chain reaction in the event the US were to impose 10% tariffs on energy products and 25% levies on everything else the country buys from Canada, which would also hit back with retaliatory measures on certain products.
With levied Canadian goods becoming more expensive in the US, demand for those products would tumble. The bank sees exports falling by 8.5% in the year after the tariffs take effect, and exporters cutting production and laying off workers.
“The shock would be felt across Canada” because exports to the US account for about a quarter of national income, he said.
Lower export revenues would reduce household income, and retaliatory tariffs would temporarily raise consumer prices above the 2% target, both of which would deter consumer spending. The bank expects consumption to decline by more than 2% by mid-2027.
The depreciation of the Canadian dollar would increase prices of imported goods and services, and integrated supply chains between two countries can add costs at multiple stages of production.
With export and consumer demand weakening, businesses would cut their investment spending. Higher costs and lower profit margins would suppress those expenditures even more. The bank forecasts investment to drop by almost 12% by 2026.
All in, a US-Canada tariff war would plunge the level of Canadian output by nearly 3% over two years and “wipe out growth” in the economy during that period, Macklem said. While the economy may expand again after the initial shock, the path for long-term growth would be 2.5% lower than a scenario where there were no tariffs.
Macklem reiterated that the bank is now “better positioned to contribute to economic stability” with inflation now back at the target, and warned there’s a limit to monetary policy response.
“Unlike the pandemic, if tariffs persist there will be no economic bounce-back,” he said. “Monetary policy cannot restore the lost supply. At most, it can smooth the decline in demand.”
He also raised concern that the initial spike in prices due to tariffs may prompt household and businesses to expect above-target inflation in the long run.
Macklem added he approves of what he sees as a focus by Canadian policymakers to increase productivity and investment “by strengthening our economic union.”
Removing rules that restrict trade between Canada’s provinces and pushing for harmonization or mutual recognition of regulations between jurisdictions “could provide some offset to increased trade friction.”
Erik Hertzberg and Randy Thanthong-Knight, Bloomberg News
