Financial Post editor-in-chief Kevin Carmichael sat down with Bank of Canada governor Tiff Macklem on Monday to discuss the central bank's decision to raise interest rates. There is a transcript of their conversation.
Kevin asked one question. The U.S. construction industry sent chunks of two-by-four to Paul Volcker because of what he did to the U.S. economy. Canadians have sent you frustration, what is the most creative way to express it?
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My correspondence is a good indicator of how Canadians are feeling. It is possible to see what is uppermost in Canadians' minds.
A year ago, a lot of the letters were from couples who were trying to buy a house. Haven't accomplished anything. They were angry. The letters are written about inflation and interest rates.
There is no doubt. Canadians feel the effects of inflation. Inflation has been high for a while. This type of inflation has never been experienced by a whole generation. People who bought houses at the top of the cycle with a variable-rate mortgage feel the strain. You empathise with these people.
There is no doubt. Canadians feel the effects of inflation.
Macklem is a person.
Do you like to read the letters yourself? Do you have an approach?
I am the one who reads them myself. I don't have a lot of help responding to them, but I read the responses and edit the letters. I usually do it on Fridays.
Is there a number you try to read in a week? There are a lot of things to do.
No, I don't have a target.
You are getting questions about variable rate mortgages. That will be used to jump to a debt question. The last decade, decade-and-a-half, has seen a lot of household debt and corporate debt run up due to low interest rates. Debt is weighing on your ability to fight inflation.
The Canadian economy is vulnerable to higher levels of household debt. For a long time, we have highlighted that.
Household debt is high. It's not even distributed. Many households saved money because they didn't spend it on vacations or go out to restaurants. That money was saved by them. Many Canadians were stuck in their homes. The people wanted more space. All of us were at home. The children were going to school. The place was all about recreation. people are looking for more space People took on more debt because interest rates were so low.
When interest rates go up, the cost of servicing that debt goes up, and the bigger the debt, the higher the service cost. Monetary policy can have more of an effect if other things are the same. The housing market is slowing down quickly.
The other side of that is that some Canadians saved money. Some people in Canada have a buffer. We want to see if monetary policy is working faster, if it is getting more traction, and what we need to do to get inflation back down.
Is it possible that policy is getting more traction than if there wasn't so much debt?
Estimates of the response to interest rates are not out of line with history. You look at the housing market in aggregate when you talk about aggregate models.
There is a large number of mortgages, but there is also a large amount of credit card data. Interest rates affect Canadians in different ways. Can you tell me how many Canadians have a variable-rate mortgage and how many have a fixed-rate one?
You can get a sense of how quickly interest rates will go up and how much it will cost. You can get an assessment of what the impact will be on their spending behavior.
The links between the aggregate models and the more micro data are tried to be drawn. Sometimes they don't match up perfectly. The challenge includes that. You get a better handle when it meshes.
What do you think of the savings rates compared to what they have been in the past? Are they buffering the effects that those who most worry about debt assume will be?
During the Pandemic, the savings rate went up a lot. It is still above pre-pandemic levels even though it has come a long way back down.
It isn't evenly distributed. Some people have more savings than others. The people in the lowest income group have less savings. They are more at risk because of high inflation.
It isn't evenly distributed, but it is giving some Canadians a bit of a buffer. You have to consider how much debt households in Canada have.
The last question was about debt. What kind of fiscal policy would help the country deal with inflation? Fiscal policymakers need to think about what to do with their budgets for next year.
I don't give fiscal advice very often. Monetary policy is a lot of work.
The governments have a lot of priorities and they need to make difficult decisions. We will build those into our view. Canadians are feeling the effects of inflation and their elected representatives are aware of that. The International Monetary Fund's advice is good. Government measures to protect people from inflation should be targeted at the most vulnerable. They feel the most pain from inflation. They are the ones who can't absorb higher prices.
These measures should be made temporarily. Monetary and fiscal policy won't be in conflict if governments listen to that advice.
Fiscal policy and monetary policy were in conflict in the 80s, according to my reading. Are you also reading that?
In the late 80s? There is some truth to that. Things were more difficult because of it.
I wanted to know if you could talk about when you would be satisfied that inflation is back to where you want it to be. Is it necessary for it to get all the way to two percent to be comfortable? Would you be okay if it entered the one- to three-per-cent band? Is that a sign that this is under control?
Right now we are very uncomfortable and I think comfort is on a continuum. It's too high of an inflation rate. It is some relief that Headline has come down. It is a bit of relief to know that it stopped going up.
Underlying inflation is around five and core inflation is over five. Some green shoots can be seen if you look at three-month moving averages. Core should come down if those continue to come down.
The core is going to be uncomfortably high for a while. When the snow starts to melt, we expect to see the effects of our higher interest rates start to work and you should be able to see core moving lower. That will be comforting if we begin to see that. We are aware that we have a long way to go before we reach our target of 2%. We won't sleep easy until price stability is restored and inflation is less than two per cent.
So it's 2%? There has been some confusion about what the Bank of Canada sees as the target. The previous governor told us that anything in the range could be acceptable.
Two percent is the target. The range gives you an idea of what a normal variation would look like. It doesn't mean you won't be outside from time to time, but you should be in the range more than 50% of the time. Aim for the middle of the range if you want to be in the range more than half the time.
Now is the best time to go back to your year-end speech. There are some lessons to be learned from not anticipating the surge in inflation. What are you going to do with those lessons?
Three lessons were laid out by me. It's hard to restore supply than demand. Some inflationary pressures can be missed when you focus on the aggregate. There is a bigger effect on inflation when the economy is in excess demand.
How are we respecting those? There are three ways to get there.
If you want to look at the economy more broadly, you need to look at some different types of data. You will get a few examples. Mobility index, restaurant bookings, and other non-traditional indicators were used to gauge whether people were getting back to normal or not. People are responding. It was useful to get a sense of how quickly people were returning to normal activities.
The nature of supply shocks has surprised us. As long as they work, we just take them for granted. When one thing goes wrong the whole thing gets gummed up. We put together a heat map of a whole range of supply chain indicators and they are colourcoded so you can look at them individually, but also see the total effect. They were mostly red, but then they changed to yellow. There are some that are yellow and some that are green. Improvements have been made there.
We looked at a lot of labour market indicators. Those are reported on our website. Data on credit card spending and mortgages has been useful. That is the first bucket.
We are looking at ways to enrich our models. If you want to understand how a supply problem on the other side of the world affects Canada, you can use the input/output structure of the Canadian economy.
When inflation went up to seven, eight per cent, we saw that companies increased their prices by more and changed their prices more often. The pass-through of higher input prices was coming much quicker than it had in the past. Businesses change prices in a lot of our models. When inflation goes up a lot, we need to allow firms to change how much they change prices, as well as the Frequency. Inflation last year was four and a half percent. Businesses were not changing the frequencies. As we got through the late spring and summer, you could see the price changes going up.
We have had fluctuations of inflation, but inflation has never gone up to seven or eight per cent. Five per cent was the previous high. Assuming it was constant was a reasonable approximation. Inflation is not a reasonable approximation when it is seven/eight per cent. We need to make our models better.
We have been working on being better at listening and communicating. We can travel across the country now that the Pandemic Restrictions have been lifted. I was in the city a few weeks ago. It is an opportunity to speak to a live audience, but it is also an opportunity to visit businesses and learn more about what is happening in the area. What are people's top priorities?
The Business Outlook Survey has been very useful during the Pandemic. A structured interview is done once a quarter. We have a long time series now. The Business pulse survey is a digital online survey that gives us good reach into small and medium-sized businesses. We don't have a long-time series, so you have to be careful in interpreting it, but you can be a bit more up-to-date. You have seen us talk about that in some of our reports.
The economic models led to a misinterpretation of what was happening. The models gave you a fake head, if not worse. Is the way we do policymaking dependent on mathematical modelling? Is taking a step back and trying to do less a lesson?
There are limitations to models when you are dealing with something that is unprecedented. The models are going to have more limitations than usual. The average of history is reflected by models. If something happens that isn't in history, your model isn't going to do a good job of capturing it
If we didn't have models, we would have had a better response. Some uncertainties were present. Our models are still helpful. There are limitations to any model. If you want to use more than one model, you need to add other information. Don't make it fake. It's a good idea to talk to businesses. The Business Outlook Survey and Business pulse survey have been helpful in that regard.
There is a lot of judgement. The evidence needs to be weighed. Think about the risks. We might be wrong about this. We might be wrong about that. I don't think monetary policy is ever going to be a model based exercise where you can just feed it all into a model and your answer is going to come out.
Economics is a study of people's behavior. People are going to react to things that have never been done before.
Before we run out of time, I want to ask a few questions. You observed that companies passed through higher commodity prices on the way up, and you will be watching to see what happens when they come down. Is that what you meant?
By that, I mean two things. One of the things we have seen through this recent period of high inflation is that it reminds us of how much inflation affects the competitive system.
When energy prices go up, companies pass on the higher input prices to the final goods prices very quickly. Inflation has gone up so fast because of that. Why is that happening? Businesses were not able to meet the demand from their customers. They were not worried that if we raised our prices, we would lose customers. They weren't able to meet all of the demand. They passed it through quickly. Price shocks to commodity prices can have a bigger and more rapid effect when the economy is in excess demand.
One of the things we want to restore is the competitive system. If companies raise their prices, they will lose customers. We want people to shop around. You can't blame households when inflation is seven/eight per cent and it's broad based. We want to see that competitive process restored so that businesses don't raise prices once inflation comes down.
If companies raise their prices, they'll lose customers.
Macklem is a person.
We have seen inflation go up rapidly and businesses pass on higher input costs quickly. Some of those prices are rolling over. The price of oil has come down a lot. The cost of shipping is going down. The prices of agricultural products have come down. Companies protected their margins and passed on higher prices quickly. Companies are expected to pass on the lower input prices.
Is it surprising that the pass-through was rapid? There was an argument that bigger companies in highly concentrated industries would use their market power to absorb inflation in order to retain their market share.
The competition authority isn't us. Competition policy will be left to the Competition Bureau.
It had a lot to do with the economy being too hot. Inflation was around 4% a year ago. The unemployment rate was higher than it is today. We changed our Christmas plans because of Omicron. Two per cent was the inflation rate for services. Even putting in a shelter, it still wasn't very high. Inflation wasn't broad based. Even though inflation was above our target, we did not see price changes increase.
The economy reopened quickly and kept going. There wasn't any more waves. Households were eager to catch up on services they had not been able to get in person. The companies couldn't keep up. They didn't have enough to meet the demand. The pressure on prices was put on by that. The prices went up very fast.
A series of disinflationary forces have been reversed. Canadians should not have confidence in the monetary policy regime that was put in place during a different time period.
Two things would be said by me. There is no trade-off between the two. Canadians have to deal with inflation every year if it's high.
Coming back to the goal. Why less than 2%? The inflation target has been reviewed many times. Since 1995 we have had a thorough review of the target. A lower target has been considered by us. A higher target has been considered by us. Two continues to look like a good target.
The main reason is that inflation is low enough that Canadians don't need to worry about it. The price level isn't important to the lives of most people year to year. The cost of living is not going to change a lot. We aren't going to hit 2% every year. It should be between one and three in most instances. Canadians won't see a big change in their cost of living over the course of a year. They don't have to worry about that. They don't have to worry about the decisions they have to make. Public good comes from low inflation.
We will have to adjust to some big forces that are affecting our economy and other economies in the future. I don't think giving up on two-per-cent inflation will help. It gets more complicated if we don't have price stability.
Kevin Carmichael can be reached via email at kcarmichael@postmedia.