Stephen Poloz: Central banking needs to be reinvented to deal with global threats

OTTAWA — If there is a lesson to be learned from the financial crisis and economic collapse of only a few years ago, it is that monetary policy needs to continuously adapt to new — an unexpected — global threats.

Even better, policymakers should fortify their economies against the unknown shocks yet to arrive, something Canada’s top central banker argues needs to be urgently addressed.

“While central banks were diligently maintaining low and stable inflation, we witnessed the emergence of massive imbalances, and unprecedented expansion in leverage, a global financial crisis and a synchronized downturn in the world economy,” Stephen Poloz said Tuesday.

“Thanks to some deft policymaking, the global economy avoided, barely, a second Great Depression,” the Bank of Canada governor said in a speech at Western University in London, Ont.

The experience of the past decade makes a pretty strong case that “central banking needs to be reinvented,” Mr. Poloz added. “Keeping inflation on track certainly was not sufficient to keep us out of trouble. . . . At the very least, it seems to me that we need to take into account of a wider range of economic and financial consequences while targeting low inflation.”

The Bank of Canada has already begun that process with a review of its five-year policy mandate that will come into force in 2016. In 1991, the BoC became the second central bank — after New Zealand — to adopt an inflation-targeting regime. They were joined by other major central banks over the next 10 years.

Similar to policymakers in many of those other countries, the Bank of Canada has set an inflation target of 2%, the midway mark between a comfort band of 1% to 3%. The bank uses its main policy tool — the key overnight lending rate to financial institutions — to nudge commercial borrowing levels toward its target.

Last month, policymakers lowered their overnight rate to 0.75% from 1%, where it had been idling since September 2010 as the central bank attempted to fire up borrowing by consumers and business to help expand the economic recovery.

“In Canada, and elsewhere, consumers and businesses could make longer-term financial plans with more confidence,” Mr. Poloz said Tuesday. “Interest rates were lower, and economic cycles were more moderate. Unemployment was lower and less variable than in the past.”

However, he said, “confidence that keeping inflation low and stable would keep us out of trouble had bred complacency, and complacency bred calamity.”

“Although we are not out of the woods yet, it is nevertheless the right time to be thinking about what monetary policy should look like once we are,” he said.

“We need to develop a monetary policy framework that integrates inflation risks and financial stability risks, both statically and dynamically, and capture much more accurately the uncertainties we face — in short, a true synthesis that takes full account of the lessons of the past, both new and old.”

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