The Bank of Canada has struggled recently to carry out its current mandate. Inflation has run consistently below its two per cent target over the past decade, and many see deflation as a serious risk. Is it time for the Bank of Canada's inflation target to be raised? In their paper, Luba Petersen, Professor of Economics at Simon Fraser University, and Shannon Wells, Director of Impact Investing at MaRS Discovery District, argue that the Bank of Canada should be aiming for three per cent inflation, or perhaps even higher.
Heading off the risk of deflation is not the only reason for raising the target: a higher rate of inflation would give the Bank of Canada more room to respond to a recession. In any case, the remarkable accumulation of public debt during the covid-19 pandemic may make a higher rate of inflation inevitable. The authors discuss how a new, higher target could be implemented and offer some insight from laboratory experiments on how expectations about inflation can be changed.
Michael Devereux's response accepts many of these points, but also expresses concern about the Bank's ability to credibly commit to a higher inflation target, especially when inflation is running persistently below the two percent target. Moreover, the effects of higher inflation on the exchange rate may cause further problems with international competitiveness. It also notes that the communication challenges behind a strategy of holding interest rates low in order to have higher interest rates later may be considerable.
Luba Petersen and Shannons Wells make the case for a higher rate of inflation.
