The Bank of Canada (BoC) is scheduled to release its latest statement on interest rates today. It’s widely expected that the Mark Carney led central bank will keepÂ its benchmark overnight lending rate at 1%.
That would be a poorÂ decision. As we’ve argued in previous blogs (back on Dec. 13Â & Jan. 7), the BoC’s lax money policy has fueled a debt binge among Canadian households. Based on the Taylor rule, the BoCÂ should beÂ moving ratesÂ towardsÂ the 3.5 – 4% zone.Â Yields on longer-term bonds, where the central bank’s influence is limited relative to market forces,Â point toÂ the same range.
YetÂ this is assumingÂ that the BoCÂ ought to be targeting a 2% inflation rate.Â A reader — Kalim Kassam Â — wonders whether the BoC shouldn’t be more serious about price stability and aim for zero inflation.
This has recently been proposed by Maxime Bernier, a federal MP in the Conservative party caucus and formerly the Minister of Foreign Affairs (until it came out that he left sensitive documents at his girlfriend’s apartment).Â Bernier’s rationale is that inflation, “is the equivalent of a tax, the most insidious of all taxes … It eats away at our purchasing power, our revenues and our savings.â€ If the BoC were to take up Bernier’s suggestion, the Taylor ruleÂ implies that rates would have to move as high as 4.5 – 5%.
Targeting zero, it must be said, would not eliminate the prospect of money supply induced booms. The chief source of economic growth is increased productivity, equivalent to a greater supply of goods at each price point.Â AssumingÂ the available money with which to demand goods remains stable, growth necessarily translates into a declining price level, that is, deflation. Each person becomes wealthier as a result because their labour and savings can purchase more goods.
ButÂ using monetary policy to keep the price level unchanged would essentially involve the raising of prices in order to undo this deflationary movement. As L.A. Hahn neatly put it,Â thisÂ sort of price stabilization wouldÂ constitute, “an inflation without inflation”.
In periods of significant productivity improvement, this is likely to generate malinvestments that don’tÂ show up in consumer price indices. This is precisely what happened in the 1920’s and, more recently, in the 1990’s with the Internet-telecomm bubble.
To be sure, such processes are just as apt, if not more so, to occur under a 2% inflation target. Still, when all is said and done, we are dealing with two very similar evils.Â Â In general, the price level should be allowed to go wherever the market dictates.
We classical liberals are better off focusing our energies on questioning theÂ existence of a monopoly setter of interest rates, rather than the criteriaÂ which that monopolistÂ ought to be usingÂ toÂ adjust those rates. We can still criticize the central bank for pursuingÂ a particular level of interest rates. But it must always be doneÂ as part ofÂ the greater project ofÂ demonstratingÂ that no agency should be empowered by the stateÂ to establish the price of credit for the entire economy.