LIMA, Peru — Some policy makers think it is their job to worry. Stephen Poloz approaches his position as governor of the Bank of Canada slightly differently. He thinks it is equally important to puzzle over how what could go right.
This doesn’t mean Poloz ignores the bad stuff. He assured an audience of international bankers in Lima Saturday that he is watching “closely” the heavier and heavier debt loads Canada’s households seem determined to carry. That burden, combined with soaring house prices in Toronto and Vancouver, has prompted some foreign investors to turn negative on Canada. Some of those people likely were in Poloz’s public at the annual meeting of the Institute of International Finance, a sprawling association of the world’s biggest banks.
Yet Canada’s central bank governor makes a point of resisting the human impulse to obsess over the worst-case scenario. “Uncertainty is two-sided,” Poloz told a few reporters after his speech; reporters, it should be noted, who had spent the previous several days listening to smart people obsess over worst-case scenarios related to the global economy. “We don’t talk excessively about upside risks in situations like these.”
Those are the kinds of comments that earned Poloz the moniker, “Sunny Stephen.” That’s a mischaracterization because it suggests an element of blind optimism. Poloz’s assessments are based on a careful weighing of all the elements that could influence inflation, the Bank of Canada’s lodestar. Consider the global economic outlook. Poloz was in Peru to attend the annual meetings of the International Monetary Fund. The IMF this week forecast that the world’s gross domestic product would expand 3.1 per cent in 2015, weaker than previously thought and near a level that some associate with a global recession.
The downgrade introduced a sense of gloom, and officials have spent the week talking about what’s going on in China and whether other emerging markets can recovery from the collapse of commodity prices. Weaker international demand would be bad for Canada as it would slow exports. Yet Poloz refuses to get carried away with that scenario. He called the IMF’s revision relatively minor, a 0.2 percentage point shift from its estimate in the summer. Just as crucial in guessing the path of inflation is an important “upside risk” — the possibility that the economy of the United States could bust out. That would stoke animal spirits, which in turn would prompt a surge of investment. Poloz told reporters that forecasters chronically miss this turning point because it tends to happen quickly. His point: there is as much reason to anticipate upward pressure on inflation as downward pressure.
Let’s get back to Canadian house prices and debt. Those who are most worried about the situation believe the Bank of Canada is flirting with a financial crisis by dropping its benchmark interest rate so low. Poloz said in his speech that the central bank knew when it cut the overnight target in January and then again in July that it was creating an incentive for households to add to their debt burden. But again, the primary concern was the inflation target. The dramatic drop in oil prices had wrecked the Bank of Canada’s inflation forecast — without lower interest rates, deflation could become a present danger. “We knew that easing policy would have implications for financial stability,” he said. “We also knew that those concerns had to remain subordinate to the primary mission of achieving our inflation target and getting our policy back in the zone where risks are balanced.”
Those who wish to understand the Bank of Canada will need to get used to this way of speaking. Risk management is central to the way Poloz conducts policy. He accepts that the financial crisis is evidence that there is more to monetary policy than moving interest rates up and down to keep inflation near the target of around 2 percent. But it will take a lot to persuade him to raise borrowing costs simply to deflate asset-price bubbles. That is the job of “macroprudential policy,” measures that seek to curb risky behaviour, such as setting minimum down payments for insured mortgages. “Even in extreme conditions, when financial stability risks constrain monetary policy from achieving its inflation target over a reasonable time frame, a central bank would want to ensure that all macroprudential options were exhausted before trying to address those risks with monetary policy,” he said in his speech.
That’s an interesting assertion. Unlike the Bank of England, the Bank of Canada lacks the ability to set macroprudential policy. Instead, it is a member of the Senior Advisory Committee (SAC), a behind-the-scenes grouping of regulators that is the closest thing Canada has to a such an authority. Some think the Bank of England model is superior. The SAC operates in private, obscuring accountability and making macroprudential policy susceptible to political whims. These are theoretical concerns. Unsurprisingly, Poloz weighs them against what he has observed. Most agree the various post-crisis measures the Harper government implemented to restrain the housing market were effective. “The test is how it has performed,” Poloz said of Canada’s macroprudential regime. “It seems to me it has performed quite well.”