Why was the Bank of Canada so wrong for so long?

When you make the same mistake for four years in a row, hard questions have to be asked

Canada’s economic recovery is expected to evolve largely as anticipated in the October Report, with the economy returning to full capacity and inflation to the 2 per cent target in the third quarter of 2011 [Monetary Policy Report, January 2010]

…the Bank [of Canada] continues to expect that the economy will return to full capacity by the end of 2012 [Monetary Policy Report, January 2011]

…the economy is only anticipated to return to full capacity by the third quarter of 2013 [Monetary Policy Report, January 2012]

…the economy is now forecast to return to full capacity only in the second half of 2014 [Monetary Policy Report, January 2013]

…the Bank expects that the economy will gradually return to its full production capacity over the next two years [Monetary Policy Report, January 2014]

For four years, the Bank of Canada has been saying that the economy will return to potential—the level of activity where there are no inflationary or disinflationary pressures—over the two years following the publication of the forecast. The gap has not closed, and it continues to provide downward pressure on inflation, which has been below the Bank’s two per cent target for the past 18 months.

This pattern raises some questions, such as “Why does the Bank of Canada keep making the same projection over and over again?” The simplest answer is that’s what the Bank’s models keep predicting. When the model is hit with a negative shock, the economy converges to its previous state, and it would seem that according to the models that the Bank uses, the average time it takes to return to potential is about two years.

No one—least of all the people who make them—should be surprised when macroeconomic forecasts go awry. Even the best-calibrated economic models will be thrown off by things like political crises or natural disasters. The financial crisis in 2011—brought about by the U.S. debt crisis and events in the Eurozone—is an obvious example. But if you’re making the same mistake for four years in a row, some hard questions have to be asked.

Of course, asking hard questions is the easy part; the challenge is in answering them. In the Bank’s defence, the first part of the recovery relied on domestic factors and went more or less according to plan. The government implemented a textbook stimulus program that was timely, targeted and temporary. And Canadian consumers responded to low interest rates by shifting forward purchases of houses and other consumer durables. But there is a limit to how far this growth driver can be pushed before consumer debt goes from being a solution to being a problem in its own right, and we are probably closer to that tipping-point than we would like to be.

The next part of the recovery was supposed to have been driven by investment spending and by a recovery in the rest of the world, but it hasn’t worked out that way. So it could be argued that the Bank’s projections have been thrown off by a recovery in the rest of the world that has stubbornly refused to get off the ground. But a weak world recovery is hardly a convincing explanation: the Bank of Canada has all the tools it needs to carry out its inflation-targeting mandate. As we have seen recently, simply dropping the tightening bias has so far generated a 6 per cent exchange rate depreciation.

Some observers—including Econowatch’s Mike Moffatt—have been calling for looser monetary policy for many months now. (In Mike’s case, these calls go back to mid-2012.) So why did the Bank of Canada stick to its tightening bias for so long? I can think of at least two reasons that don’t amount to saying that the Bank simply dropped the ball—although that possibility can’t be dismissed out of hand:

The low-for-long problem: Everything else being equal, lower interest rates increase asset prices. The risk is that interest rates that are very low for very long could produce the sort of asset price bubbles—especially in housing—that have wreaked havoc in the US and Europe. There was some discussion in the months leading up to the renewal of the Bank of Canada’s inflation target about modifying the mandate to take into account developments in asset markets. These changes didn’t enter the new mandate, but it could be argued that to the extent that higher rates prevented house prices from rising more than they did, the Bank was preventing even greater deviations from target in the future. The fact that these concerns are receding may explain why the Bank recently moved away from the tightening bias.

The beggar-thy-neighbour problem: When it comes to currency wars, the Canadian dollar is like a ninja: it moves quickly, to great effect and no-one seems to notice it. But once the employment losses had been recovered—and while employment in the U.S. was still severely depressed—a weaker CAD could have generated frictions on the international front. So long as the Federal Reserve felt constrained in its efforts to implement unconventional measures such as quantitative easing, a lower Canadian dollar would be viewed as an unwelcome development in the U.S.. Again, now that the U.S. recovery seems to be on much more solid footing, these concerns are also easing.

There may be other scenarios. We’ll probably never know how and why the Bank let inflation drift below target for so long. It would be nice if the Bank’s Governing Council took a page from the Fed’s procedure book and published the minutes of its deliberations.




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Why was the Bank of Canada so wrong for so long?

  1. The true measure on how the economy is doing are stock values. Even though stocks have gradually climbed from the melt down 2007 they are still worth 0nly 60% of the values they posted in 2006 on an average. There are exceptions to that value but those are primarily from external influences. A good rule of thumb for comparisons is, SUNLUFE, in 2006 it was worth over $50/shr. and now it is struggling at the $30/shr level.

    • Stock markets can be measure of a bubble rather than true economy… eg stock market crash of 1929 after years of borrowing money to buy stocks

      As far as future goes, no mention in article about government debt… US, most of europe, ontario, california, new york, many major cities are following the pattern of greece and detroit. Eventually bond rates go up and downward spiral accelerates. US for example has gone from 5 trillion to 16 trillion debt in 12 years.

      Comparing debt to GDP only does so much good, if you borrow money you can short term boost GDP which makes it seem like borrowing money isn’t digging hole. But the borrowed money is spent, then no longer boost to GDP, but interest payments is a drag on economy.

      Canada is not going in debt as fast as most, which in short term makes Canada look worse/reduces GDP but in long term is better than for example US extra debt growth.

      Meanwhile and far away, the Fed reserve creates money from nothing, uses that money to buy bonds of companies such as apple which will pay back their debt with interest, and thus private bankers earn interest on money they never had to begin with. Because fed reserve buys these bonds, other people invest instead in US bonds which will likely be paid back with same chance as Ponzi scheme (only if you get out before end) at rate US keeps digging a bigger debt while factories/real production moves to china. (Fake production like price of real estate going up, is not really economy)

      • About 3 trillion of the 11 trillion increase was war spending, and most of the rest was caused by tax cuts for the rich and corporations… I believe our American neighbors consider that investment rather than debt.

      • Truly speaking there are no way to predict anything when it involves human instincts and inputs. That is that. Stock market can indicate some trend for a very short while and when few trading firms discover it, that should also be thrown out the window, because the trend will change very shortly thereafter. I am sorry to sound pessimistic, please stay informed with information and be careful of you decisions.

    • The stock market is a measure of corporate profitability, not the health of the economy. US markets are at or near all-time highs, but few would argue that the US economy is in great shape, or that people are better off. The link you describe simply does not exist.

      • I agree…”The stock market is a measure of corporate profitability, not the health of the economy.” Canada has a huge problem of finding solid full time employment to its citizens in the cities, that I don’t think outsiders know much about…

        • It’s the expectation of future profitability, discounted to present day.

          • Yes to some degree… As I am scared of the word “future” and thus forecasting, because of human eliment… very scary, to me

          • If you look back at the history of Blackberry (RIM) some were predicting doom and gloom when they were at their peak, just after being declared by Fortune mag as the fastest growing company in 2009.

            Of course to much consternation in parts, here and elsewhere.

          • hehehe history also states that Sir Isaac Newton lost all his fortune on one stock when he bought it too late into the bubble (apparently he is a big believer of momentum – go figure) and then turns out the entity was involved only in illegal activity LOL… Yes, I agree with you, some people can predict the peak, but that decision is still inside the human element brackets… and to go with gut feeling is too gutsy for me and I can’t understand why firms would buy into your decision when they’re money nicely riding the bubble…

    • Your “rule of thumb” is one company that you misspelled, that’s at 68% (not 60%) of its all time high, and you claim that one company is “an average.”

      In the meantime, market indices are at or near all-time highs, and well above 2007 peaks, and are a better indication of the broader market than one company.

  2. They get paid to say anything,to make people happy, like a fortune teller. They don’t work in the trenches, they don’t have the stress of maintaining a business to survive. They don’t have any real connection to the recovery at all, except for their pension. They just make up some crap cuz they know they get paid whether or not their predictions come true..

    • “They just make up some crap cuz they know they get paid whether their predictions come true.”

      Or, scary scenario, they make crap up to help the government spin its recovery story.

    • “They don’t work in the trenches, they don’t have the stress of maintaining a business to survive.”

      This is the problem… But if they have any good previous experience that might help… I also caught BOC governor, Poloz, lying on CBC saying the Canadian dollar is in par with the Australian and New Zealand’s dollars growth… That is a lie… We vote in incapable people who turnaround and hire less incapable people…

  3. While the lower Canadian dollar is probably a net benefit to our economy, I’d really like to see rates increased to keep house prices from going even higher (I’m in Vancouver and it is getting silly here) and to keep debt levels reasonable.

    • High housing prices are good for banks and investors… the only people they hurt are regular people. So we can be sure that prices will continue to rise.

      • “High housing prices are good for banks and investors…” – as long as the interest rate is low and payments are coming in… otherwise mortgage renewal followed by interest rate hike could spell trouble trouble trouble…

    • We definitely need a correction in the housing market (Vancouver 2nd highest market in the world after only Hong Kong with avg cost $800,000 and Canada is the most overpriced market in the world), and i think its better to correct while every nation on earth are in a form of predicament or another… So when we come out, we can be stable and run again, relatively, together with the other nations. Otherwise, we will be correcting while everybody are back on their feet and that could have unpredictable adverse effects… I am not for soft landing… That is just going to take more tax payers money that could go into much needed public programs such as hospitals (to reduce hospital wait times [far worse than many nations]), child care studies, old age support and divert the brewing pension problem…

      • I tend to agree with you. It would probably be for the best if prices dropped by ~30-50% over a period of six months or so. Even at 50%, our housing would still be considered overpriced compared to average incomes. The longer this goes on the worse it will for almost everyone involved, whether it crashes or not. If it crashes after another 10 years of growth, the damage will be far worse. If it keep growing without a crash then the economy/demographics/community in Vancouver will be totally screwed.

  4. Flaherty appointed both governors.

    • Bank of England thought Mark Carney was the the smartest guy they could get for the job. Flaherty should feel vindicated in his judgement. His replacement seems to follow the same mindset. Very likely another good choice.

      I for one will suggest these learned men know better than those who criticize on these forums.

      And why would we want them to share the total game plan with our opposition in the world market?

      • Mark Carney wanted out….this next one will too.

        Flaherty is an ambulance chaser.

        We don’t have any ‘opposition’ in the world market.

  5. If the Bank of Canada can be wrong in its forecasts, then surely the Finance Dept can be as well, presumably using similar models.

    Cutting GST by two points at the peak of a lengthy business cycle before a prolonged recession, resulting in a structural deficit of the same amount, has been characterized by the author as a strategy of “Starving the Beast”.

    In a similar vein, I’d like to characterize this strategy of the Bank of Canada as “Feeding the Bleats”.

    • The ‘beast” being referred to is the beast that is big government. In a society based largely on the fundamental principle of individual liberty, that liberty is best protected by ensuring that governments have limited funds. By striving to limit the finances of governments, we limit their powers and slow their inexorable tendency to grow. Liberty is always imperiled by government.

      • Had the GST cuts (est ~$12-$14 billion/yr) been made after the recession, and after a recovery when there is a structural surplus, then arguably we would have (say 2015-2008) seven years (~$90 billion) less of debt to pay-off. Whose carrying costs will increase once interest rates trend upward, coming out of the operating budget.

        Bigger beast for longer.

        • I would posit that they recession was made less harsh and prolonged by the fact that Canadian citizens, instead of the mindless and wasteful federal government, was able to retain possession of that $12-14 billion per year of GST money.
          Who do you think would be more productive in spending/investing that money?
          A- 15-20 mindless, faceless, brain dead federal employees ensconced in the statist echo chamber that is Ottawa?
          B- 33 million Canadians.
          Hmmm. I’m guessing “B” for the win, here Bob.

          • I’d say the ones left holding the mortgage, option “C”.

          • The ones holding the mortgage are the ones actually paying taxes. If letting them keep more of their own money up front leads to a less severe and shorter recession, and in turn less government borrowing AND over a shorter term, then I would have to say there is no actual option “C”.
            Always remember, governments never spend their own money, as they actually have none. ALL govt. spending is the dispersal of confiscated earnings. Every. Last. Penny.

          • Someone has to pay the Bills.

          • They continued to spend the money. You might have a great point if the revenue cut was matched by reductions in spending rather than financed with debt.

        • Racking up debt is a big part of starve the beast. Conservatives don’t mind taxes to service debts. They mind transfers of wealth.

          • Do you really think when the GST cuts were enacted, the gov’t anticipated the world recession? All evidence to me suggests otherwise.

            If racking up debt is part of the strategy, why the political focus on balancing the books by 2014/2015 , or whatever the current iteration calls for? Just keep on deficit spending.

          • because otherwise their electoral chances suffer.

          • ahhhh….the hidden agenda. Rope a dope.

            I’m of the view that incompetence trumps 3D chess in the range of explanations for the GST cuts.

          • promising to cut the GST helped get them elected. not balancing the books by the next election will damage their ‘economic credentials’.
            i wasn’t suggesting any hidden agenda, but I will certainly say this government values power over principle.

            now whether they actually like the idea of a bigger debt i don’t know. but they did go gangbusters on the Martin government surpluses, saying how wrong they were. So they weren’t after paying down the debt.

          • Basically my point as well. The focus has been on getting elected and re-elected through pandering tax cuts and credits. Crippling future gov’ts of a different colour by racking up debt is the covering narrative.

          • At the time, the PBO projected structural deficits. And governments don’t have to forecast recessions, they have to prepare for them. Recessions happen.

          • Are you suggesting then that a business cycle is not part of Finance’s forecasting model? Balancing the books at the height of a business cycle (through tax cuts) when revenues are greatest seems to me would guarantee deficits other times.

          • Usually the forecast involves projecting the economy will return to trend GDP growth over the medium term. You’re right that cutting revenues and not spending will worsen the fiscal balance and increase net deficits over the business cycle.

      • First, you seem to be ignorant of what country you’re in. Our society is not based largely on the fundamental principle of individual liberty. You’ll note our motto is “Peace, Order, and Good Government.” If you want a country that puts individual liberty in their motto, perhaps you should leave this country and move to one down south, and leave those of us who believe in this nation to it.

        Second, liberty is not always imperiled by government. Indeed, sometimes, government is the only way to provide liberty, as can be seen when we look at slavery.

        • Individual liberty is an absolute cornerstone of Canadian society. Canada is a child of Great Britain, where the concept of individual liberty has been steeped in a broth of blood, steel, literature, and law for the last thousand years. Locke, Smith, Chaucer, Churchill, More, Wren, and countless other great figures in British history remind us of the ideal of British liberty, and our entire political and legal system is based upon that great tradition of liberty.
          It is you, my good friend, that is ignorant of history, not I.
          No, liberty is not always imperiled by government. It is, however, always imperiled by governments that do not cherish and seek to uphold liberty.

          • Bill, your quote: “Liberty is always imperiled by government.” Nice to see you stand down. In context, Thwim’s response was justified.

            In addition, I’m not after bigger government, but maybe you can enlighten me on if our British parent government has ever been denied the ability to raise funds as it sees fit.

            In fact, in the spirit of individual liberty, and one person one vote, is it not up to to the citizens to vote in or out of office government based on what they do or promise to do, and that if we collectively choose to make law that we submit 100% of our incomes to the state, that would be an expression of our liberty?

          • It might be an expression of “our” liberty if the vote were unanimous. But if it were just a simple majority – say 50% + 1 – it would just be half the population imposing its will on the other half. The tyranny of the majority.

            Details like this get lost when we treat the collective as a single acting unit. All government action is legitimate if it’s the government that we chose. But we didn’t choose, because choosing is not done by the collective, but by individuals. Some of us choose one way, others another; and doubtless some intrepid individualists choose still another.

          • oh course. a real tyranny is a dictator or small group of the powerful expressing their interests over the majority, but with a collective (which is how we avoid anarchy), there’s always going to be imperfection.

            As for myself, I worked on the BC STV campaign when I lived there, because I think it better represents the whole than First Past the Post. But it too is imperfect.

            The imperfection of the collective still provides more liberty than the perfection of anarchy.

            Otherwise we’d all wish to move to Somalia.

            Your point is well taken, I understand the space in my comment for it, but it wasn’t my intent (my argument was about whether liberty and taxation had any direct relationship).

            Cheers.

          • I can’t say with any certainty if the British government has been denied access to funds. Many American states, however, have specific limitations on the ability of governments to tax, spend, and borrow new money without the express permission of the electorate. It’s not a coincidence that those are the most financially healthy governments in the United States.
            But, further to the concept of liberty we must ponder this: How far do the rights of confiscation go?
            For example, in a community of 100 people, let’s say only 45 of those people are contributing financially to the needs of the 100. The remainder are too old, too young, frail and unabled, and 3 or 4 are unwilling to contibute. All of the citizens routinely get together to discuss and vote on the financial needs of the entire group. If 55 of those people voted to confiscate for themselves more of the wealth earned by the 45 who actually earn, do the 45 have a right, or not, to say no to more confiscation?
            This is the quandary we find ourselves in. The percentage of those who contribute to the financial pool that governments rely on is shrinking every day, and those who draw from the pool are prone to voting themselves ever greater proportions from that pool.
            The question is basic, then. Who should have the greater say in how the pool is managed? Those who contribute; those who are being asked to sacrifice by taking an ever greater share of what they earn and put it into the pool, or those who draw from the pool?
            One man, one vote, is the rule of democracy. But, there are other rules, such as limiting the power of the state to the consent of the governed.
            It’s lost on most people that once you are receiving the largesse of the state, you are no longer governed, but you are the de facto governing. Whether you are a municipal worker, or a police officer, or a nurse paid via a government health authority, or a recipient of a government pension you are by default the government itself. Ergo, you have at that point no automatic right to a voice in the direction of government. You are the government, and must seek the consent of those governed when seeking the funds of those you govern.
            We have lost sight of that hard reality.

          • Hey, it’s been a long time, but I really appreciate your comment and thanks kindly for it. I have had such an argument, actually, with a certain Emily1, regarding the Boomers, who are in power, being responsible and planning civically and individually for their coming expenses. And how taking simply what they can get is selfish and irresponsible. I’m just not sure how we get around it. The majority tend to have a tyranny over the minority, laws are laws and can be changed.

            Ultimately I think a democracy lives on thinking broadly, there is intrinsically some social binding in the concept – and that the collective actually works best when we think holistically (and not do all the wrong things you mention above), but we do seem to have strayed some. I totally agree.

  6. You ask Why? and then you spend the rest of article apologizing for the Bank of Canada? What crap! The Bank of Canada is an offense to the people of Canada. It has destroyed the safety and return of seniors investments by depressing interest rates and spreading debt as fast as it can. It has destroyed the value of the Canadian dollar in order to prop up the economy. It has created a massive housing, bond and stock bubble that will soon wreak destruction on the entire country. The reason it gets away with such treason is that most Canadians are clueless when it comes to understanding economics and monetary systems and they love cheap credit. It doesn’t help when journalists pretend to ask serious questions and then just enable the criminals to do their job.

    • Did you read what you wrote buddy. They’ve kept the rate higher than the U.S. causing our dollar at one point to run up over the greenback. Our stock market has under performed. What Bond bubble? You seen the yields?

  7. It has nothing to do with the Conservative Capitalist Cult of Contrarianism?

    • You still working for the Continental Can Company of Canada?

  8. Here is an exerciser for everyone out there. Google the BOC and find out who actually owns it. You will understand why it is game over before it even starts.

  9. model…really? Inflation requires demand. You’re not going to get demand with high unemployment. And there’s been no end of job losses in the west. Europe/U.S./Canada. Should I say job migration to China/Mexico/Bangladesh/Eastern Europe. Not to mention continued automation. Have you seen those new robots Amazon is using? Now this is good for the middle-class. They can get 2 big screens and an i-phone for everybody.
    Only problem is …with all those jobs gone off-shore or automated out…there’s less middle class. Even they have their limits on T.V.’s and coffee at Tim’s. Perhaps the BofC as well as others didn’t think that for any increase in demand it could be filled by foreign labour or automation ( decreasing business cost and raising profit for the rich..which doesn’t get back into the economy as much ). No jobs>no inflation>no rate increase.

  10. Is monetary policy being polluted by politics?

    Given Prof. Gordon’s previously raised concerns and pointed comments regarding “Greatest Minister Of Finance Ever”‘s abstruse interjections into monetary policy, read into this what you will.

  11. Why do realtors always say real estate prices are going up? We keep taking the word of the foxes guarding the henhouses.

  12. Nice sharing

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