I'll continue here a discussion started in another thread:
longinvest wrote: ↑08 Jun 2019 07:33
AltaRed wrote: ↑07 Jun 2019 16:31
longinvest wrote: ↑07 Jun 2019 16:21
I don't care about the inflation of foreign countries and their central bankers; I live in Canada. I'm confident that the Bank of Canada will continue to "
preserve the value of money by keeping inflation low, stable and predictable". (See:
Monetary Policy).
You should care some about US inflation and central bank policy there. BoC will have to also
protect the loonie's value to some degree as well to stick handle import inflation to which Canadian consumers will be significantly exposed.
I have better things to do in life than worry about foreign politics and monetary policies. It seems that some FWF members like to lose sleep; they've been worried, the last few years, about the impact of the oil price crisis, tariffs, NAFTA, etc. on inflation. Meanwhile, I've slept like a baby while inflation stayed low, stable, and predictable, because the Bank of Canada has a clear and measurable objective with a very flexible framework which consists of two key components that work together: the inflation-control target and the
flexible exchange rate.
If the Bank of Canada had to "protect the loonie's value", as you wrote, or if it had to "protect the economy", it wouldn't have the flexibility required to keep inflation on target. But, luckily, its mandate doesn't involve protecting our currency. On the contrary, its monetary policy framework is explicitly based on letting our currency fluctuate.
We've seen this in action from 2014 to 20016, when the Bank of Canada let our dollar drop from $0.94 USD to $0.70 in less than two years, and also significantly dropped its policy interest rate in early 2015, allowing inflation to remain low, stable, and predictable.
Note that if the Bank of Canada hadn't acted, we would have probably experienced deflation due to the severe slow down of Alberta's oil industry. By letting the dollar drop, it created inflation (remember that the goal is 2% inflation, not 0% inflation) and it also increased the profit margins for oil producers who sell in USD yet pay salaries in CAD.
The Bank of Canada's monetary policy is amazing in its simplicity and effectiveness. I encourage FWF members to learn about it and stop losing sleep with unwarranted fears about inflation.
I think that few Canadians understand how effective the Bank of Canada's monetary policy is while being amazingly simple. Maybe I should try to explain it.
At the basis of the idea is the
Law of supply and demand. When supply is bigger than demand, prices go down. When supply is smaller than demand, prices go up.
When people have less money, they usually spend less (
lower demand). This leads to deflation (
lower prices), because sellers get desperate to sell their goods and services (higher supply than demand).
When people have more money, they usually spend more (
higher demand). This leads to inflation (
higher prices), because sellers can make bigger profits selling less goods (higher demand than supply).
The Bank of Canada wants to control inflation by keeping it low, stable, and predictable, targeting 2% within a range of 1% to 3%. Unfortunately, the bank doesn't control the domestic economy and its actors (companies, governments, workers, consumers), nor does it control foreign trade partners.
But, the Bank of Canada controls the target for the overnight rate, usually called the
key policy interest rate. This rate plays an important role in our economy. Through this key policy interest rate, the Bank of Canada can affect the cost of borrowing. The higher it gets, the more expensive it gets to borrow from a bank, the less individuals and companies borrow, the less money they get to buy goods and services (lower demand). The lower the key policy interest rate gets, the less expensive money gets to borrow from a bank, the more individuals and and companies borrow, the more money they get to buy goods and services (higher demand).
In a global economy, the key interest rate also affects the attractiveness of the Canadian dollar. A higher rate makes the Canadian dollar more attractive to foreign investors, increasing its value relative to foreign currencies and, as a result, make foreign goods and services cheaper, lowering the demand for domestic goods and services. A lower rate makes the Canadian dollar less attractive to foreign investors, decreasing its value relative to foreign currencies and, as a result, make foreign goods and services more expensive, increasing the demand for domestic goods and services.
Do you see it, now? The Bank of Canada can, through the key policy interest rate, affect the demand for domestic goods and services. The higher this demand, the higher the prices get. The lower this demand, the lower prices get. That's how it controls inflation.
The Bank of Canada doesn't have a perfect control on inflation. Prices are set on a daily basis by market participants. But, as the Monetary Policy is free from political concerns (such as employment targets, currency exchange rate target), and is based on a single objective of low, stable, and predictable inflation, the Bank has all the freedom it needs to adjust the key policy interest rate to control inflation and, effectively, keep it on target.
I hope that, by now, it has become clear to readers that, if it wasn't for the tight 1% to 3% range around the 2% target, a monkey could drive the key policy interest rate to constantly bring back inflation towards the 2% target. Luckily, our central bank is run by smart humans.
As long as the Bank of Canada doesn't change its Monetary Policy objective and doesn't add political constraints (employment targets, currency exchange rate targets), I won't lose sleep with a fear of inflation deviating from the target range.
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