Cutting through the smoke: Bank of Canada's credibility at top of Poloz's mind as he raised rates
Ahead of last weekâs interest-rate announcement, I talked to a Bay Street economist who wondered how much credibility would factor in the Bank of Canadaâs decision. Quite a lot, as it turned out.
âItâs always top of mind,â Stephen Poloz, the governor, told me in an interview after the Canadian central bank raised the benchmark rate for the first time in six months on July 11. âIf you were thinking about doing something differently, your explanation would (have to) be very rigorous because youâd be thinking, âWell, my credibility is at stake if people think, âoh thatâs just smoke.ââ You canât put out something thatâs just smoke. No one is going to buy it. So you need to have really good reasons for whatever it is you do or donât do.â
Those who thought the Bank of Canada would â" or should â" leave interest rates un changed last week appeared to put too little weight on what such a swerve would have meant for the central bankâs reputation.
The vast majority of market participants had judged, correctly, that the central bankâs conditions for an interest-rate increase had been met. The Bank of Canada is constantly processing information, but policy makers had made clear that they were primarily interested in three things: business investment, exports, and the response of heavily indebted households to higher interest rates. Data on all three of those items had been mostly positive. Inflation was on target, but with upward momentum.
When policy makers left interest rates unchanged at the end of May, they said they still believed that borrowing costs needed to be higher. Therefore, if they hadnât raised the benchmark rate last week, they would have needed a compelling reason to disappoint so many people. There wasnât one. Assuming that U.S. President Donald Trump, a consistent liar and flip-flopper, is serious about wrecking the global trading system would have looked like âsmokeâ against hard evidence that most Canadian exporters are expanding to keep up with orders.
The Bank of Canada acknowledged that punitive U.S. duties on automotive imports would hurt Canada, but a resolution to trade differences is also a possibility. The later could boost economic growth and put upward pressure on inflation, which is ultimately what the central bank cares about.
âThere are lots of things I could tell you that are big and nice, as opposed to hairy, that weâre also not allowing to influence our decisions,â Poloz said in the interview. âFor example, NAFTA gets restored. Boom. Aluminum and steel tariffs just go away. We should put a higher weight on that possibility than on auto tariffs, frankly. But, you know, theyâre both big and theyâre harder to quantify.â
Poloz isnât sticking his head in the sand. Rather, heâs reinforcing h is message of the past few years that Canadian monetary policy will be guided by a careful, meeting-by-meeting analysis of data, not a predetermined path or hypothetical scenarios.
Trade dominated deliberations, suggesting that if there was a reason to panic, the men and women on the Governing Council would have found it. Household debt remains a threat, but the central bankâs analysis of mortgage data found relatively few Canadians will be forced to renew their home loans over the next couple of years. That means most homeowners have time to prepare for higher interest rates. Bottom line: there was no good reason to avoid raising interest rates last week, at least according to the conditions that the central bank had set.
Itâs easy to forget about the role credibility plays â" or should play â" in policy making because so few in Ottawa are committed to it.
Last month, Foreign Affairs Minister Chrystia Freeland justified her governmentâs decision to reta liate against U.S. aluminum-and-steel tariffs by citing the âdegree to which there is national solidarityâ on the subject. There is no evidence in that answer that the government has thought through what it is doing. The decision to engage Trump might be popular, but it lacks credibility because no one has offered a thorough explanation for why tit-for-tat was chosen over other tactics.
Credibility matters. In 2015, when oil prices collapsed, the Bank of Canada cut interest rates to cushion the blow. But Mexicoâs central bank had to raise interest rates to slow capital flight and keep the countryâs currency from collapsing. The Bank of Mexico is highly regarded by its peers, but it hasnât established the complete trust of international investors yet.
Anyone interested in understanding the way Poloz approaches his job should keep Mexicoâs recent experience in mind.
âThey just got pounded, absolutely pounded, way outsized compared to the size of their shock and their economy,â he said. âWe donât want to have any risk of that happening to us. Thatâs why (credibility) matters so much.â
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