It’s time for an adult conversation about inflation

Don’t blame the Bank of Canada for the sharp rise in inflation that followed the Covid pandemic. Once Ottawa decided to keep Canadian households and businesses afloat without a plan for who would foot the bill, there wasn’t much Stephen Poloz or his successor Tiff Macklem could do to curb its inflationary impact. In fact, the two Bank of Canada governors deserve credit for not making things worse.

That’s the headline from a C.D. Howe Institute paper published this week by David Andolfatto and Fernando Martin entitled An Assessment of Canada’s 2021-22 Inflation Surge. Andolfatto is professor and chair in the department of economics at the Miami Herbert Business School, University of Miami and an international fellow at C.D. Howe. Martin is a senior economic policy advisor at the Federal Reserve Bank of St. Louis.

The paper blames fiscal policy for post-pandemic inflation, specifically that Ottawa had no plan to fund the measures it took during the pandemic.

“[C]riticism that the Bank of Canada was slow to react to inflationary pressures may be off the mark,” Andolfatto and Martin wrote. “Given the nature of the crisis and the fiscal response, discouraging the inflation surge would have inhibited economic recovery and worsened the fiscal burden.” It would have made the recovery slower and more painful.

Andolfatto and I spoke on Thursday. He is reluctant to “be an armchair quarterback,” particularly given his own experience at the Federal Reserve Bank of St. Louis during the financial crisis. Andolfatto joined in 2009 as a senior vice-president and advisor to the president. “I don’t like to criticize policy makers,” he said. “You know, in the middle of a war.”

Covid was certainly that — a toxic mix of health and politics from the start. Federal and provincial governments knew they’d have to support millions of Canadians as the economy all but locked down. But there was precious little consensus on what that should look like.

“Parliament could have passed a temporary increase in the GST,” Andolfatto said.

That would’ve been the right thing to do. But to be fair — and Andolfatto recognizes this — it’s unlikely that then Prime Minister Justin Trudeau’s minority government could’ve got that through Parliament.

Instead, the Department of Finance decided to issue government bonds without any accompanying plan to raise taxes or cut spending down the road.

“It was unfunded,” Andolfatto explained. “The government [made] no implicit or explicit guarantee that it was going to reverse those purchases. It just [said], we’re going to create billions of dollars of extra government paper, and we’re just going to let it circulate forever.”

The economy couldn’t possibly absorb that additional capital without inflation being the result. Add to that the real impact of global supply chain disruption.

There was “probably very little [the Bank of Canada] could have done to prevent the inflation surge,” Andolfatto said. “Any action it might have taken to prevent it would have only postponed it, and might have made things worse because it would have had to raise the interest rate in a manner that might have suppressed the recovery.”

The takeaway from all this is that Ottawa needs to prepare for the next disaster — now.

“This is not going to be the last emergency,” Andolfatto said. “We have to think about the protocols, the criteria that we have in place for determining where the money has to flow and how it’s going to be financed. And there has to be broad buy-in in Parliament, not just the government.”

Canadians need to take a bit of responsibility too. “Somebody has to pay,” Andolfatto said.

“Let’s be adults about it,” he said. “I think very few Canadians would say that some [wealth] redistribution wasn’t needed. I mean, we were asking segments of the population to sacrifice their earnings capacity to flatten the contagion curve. I’m willing to discuss and debate and criticize even that perhaps they went too far. Too many people got money that shouldn’t have, of course. But the concept of fellow Canadians helping each other out during a crisis, … that’s the adult conversation.”