The full effects of interest rate hikes have yet to be felt – and will be “even more powerful” than many anticipate, former Bank of Canada governor Stephen Poloz said.
Speaking at a conference hosted by Western University’s Ivey Business School in Ottawa on Thursday, the former governor warned today’s economy is more sensitive to interest rates than it was 10 years ago.
“Does anybody here think the sensitivity of the economy to interest rate movements is less today than it was five or 10 years ago?” Poloz asked. “I think it’s more sensitive today than it was before.”
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Poloz estimates annual inflation will fall to about four per cent on its own as external factors, such as higher commodity prices, ease. Statistics Canada’s most recent annual inflation rate sat at 6.9 per cent in October.
He said policy action will need to do the rest of the work to get inflation back down to the central bank’s two per cent target.
“I think that the actions that are being taken to get us there will turn out to be even more powerful than a lot of people think,” Poloz said.
The Bank of Canada began raising interest rates in March to clamp down on rising inflation. Since then, the central bank raised its key interest rate six consecutive times, embarking on one of the fastest monetary policy tightening cycles in its history.
Its key rate currently stands at 3.75 per cent and is expected to rise again next month.
The aggressive rate hikes are expected to slow the Canadian economy significantly. And though many economists are cautiously optimistic that the slowdown won’t be severe or long-lasting, labour groups in particular have been concerned about the consequences of a potential recession.
Is the Bank of Canada overshooting with its rate hikes? “It’s impossible to say,” Poloz said in an interview.
Economists estimate interest rate hikes take one to two years to take full effect on the economy. That lag makes it difficult to judge whether rate hikes are too much or too little, the former governor said.
Poloz said trying to slow inflation with interest rate hikes is like trying to stop a car with bad brakes.
“It takes a long time to actually slow down and so you stand on the brake really hard. Well, then you’re going to cause an accident too,” he said.
Though high inflation has persisted longer than the Bank of Canada’s initial projections, Poloz defended the use of the word “transitory” to describe inflation pressures, noting in his speech that international contributors to inflation such as supply chain delays are already dissipating.
“In other words, the part of inflation that is externally driven, really is transitory. It’s OK to use the word transitory,” he said.
However, the former central bank governor says it takes time for that development to be reflected in the annual inflation rate.
Bank of Canada governor Tiff Macklem notably called inflation “transitory” – meaning temporary – when it first started rising.
Since then, he’s backed away from that characterization and has emphasized that the domestic economy is overheated and inflation won’t return to target without action from the central bank.
