An analysis of the indicators relevant to the Bank of Canada’s inflation target, and a look at the bank’s monetary policy stance, shows the bank’s policy rate lagged behind the ideal level predicted by policy targeting rules, says a recent monetary policy report from the C.D. Howe Institute. (The report looks at these rules in some depth.)

Entitled Slaying the Beast: The Bank of Canada’s Ongoing Battle With Inflation, the report says “the evidence suggests the Bank of Canada is right to pause its tightening cycle.” 

Describing events which led to the current inflationary state, they say “the pandemic recession resulted from a simultaneous decline in supply and demand. The forced shutdown of many sectors of the economy reduced supply. The temporary or permanent loss of jobs combined with a lack of spending opportunities caused a drop in demand,” they write.

“When the economy began re-opening, pent-up savings led the growth in demand to outstrip the growth in supply. Supply was constrained by supply-chain bottlenecks, primarily caused by lockdowns. They proved to be more persistent than the Bank of Canada (and many other analysts) anticipated, in part because of labour re-allocation away from sectors that were locked down and hard to reverse. As the growth in demand outstripped growth in supply, inflation soared.” 

They continue, saying underestimating supply constraints led the bank to fall behind the curve when raising its policy rate to fight inflation.

The report goes on to look at the effect money growth had on inflation. “As things opened up, this money overhang (think stimulus and quantitative easing programs) combined with supply-chain snarls caused more money to chase fewer goods, leading to above-target inflation.” 

They conclude saying no more tightening is likely necessary, as inflation will continue to shrink until it is back in line with where it was pre-pandemic. “Evidence suggests that the bank’s rate tightening cycle should be at its end. Headline inflation, which peaked in June 2022, should continue to decelerate, aided by falling trend money growth,” they write. “The Bank of Canada is right to pause its tightening cycle.”