Effect of interest rate hikes on Canadian economy will be ‘more powerful’ than people think, Poloz says

The full effects of interest rate hikes have yet to be felt – and will be “even more powerful” than many anticipate, said former Bank of Canada governor Stephen Poloz Thursday in a speech about ways Canada can chart a path toward economic growth during uncertain times.

Speaking at a conference hosted by Western University’s Ivey Business School in Ottawa on Thursday, the former governor warned today’s economy is more sensitive to interest rates than it was 10 years ago.

“Does anybody here think the sensitivity of the economy to interest rate movements is less today than it was five or 10 years ago?” Poloz asked. “I think it’s more sensitive today than it was before.”

Poloz estimates annual inflation will fall to about four per cent on its own as external factors, such as higher commodity prices, ease. Statistics Canada’s most recent annual inflation rate sat at 6.9 per cent in October.

He said policy action will need to do the rest of the work to get inflation back down to the central bank’s two per cent target.

“I think that the actions that are being taken to get us there will turn out to be even more powerful than a lot of people think,” Poloz said, citing higher debt loads in the Canadian economy as a vulnerability.

The former governor is the chair of the Lawrence National Centre for Policy and Management, an independent think tank hosted at Ivey.

Poloz began his remarks by sharing his thoughts on the drivers of high inflation and where prices are headed. His speech also offered a set of recommendations on how Canada can improve long-term economic growth during volatile times.

He said the think tank will offer a summary of the recommendations to Finance Minister Chrystia Freeland next week.

Poloz finished his seven-year term as Bank of Canada governor a few months into the COVID-19 pandemic. Since then, the central bank has dramatically shifted gears from the extraordinary stimulus measures of 2020 to rapid monetary policy tightening.

The Bank of Canada began raising interest rates in March to clamp down on rising inflation. Since then, the central bank raised its key interest rate six consecutive times, embarking on one of the fastest monetary policy tightening cycles in its history.

Its key rate currently stands at 3.75 per cent and is expected to rise again next month.

The aggressive rate hikes are expected to slow the Canadian economy significantly. And though many economists are cautiously optimistic that the slowdown won’t be severe or long-lasting, labour groups in particular have been concerned about the consequences of a potential recession.

Is the Bank of Canada overshooting with its rate hikes? “It’s impossible to say,” Poloz said in an interview.

Economists estimate interest rate hikes take one to two years to take full effect in the economy. That lag makes it difficult to judge whether rate hikes are too much or too little, the former governor said.

Poloz said trying to slow inflation with interest rate hikes is like trying to stop a car with bad brakes.

“It takes a long time to actually slow down and so you stand on the brake really hard. Well, then you’re going to cause an accident too,” he said.

Though high inflation has persisted longer than the Bank of Canada’s initial projections, Poloz defended the use of the word “transitory” to describe inflation pressures, noting in his speech that international contributors to inflation such as supply chain delays are already dissipating.

“In other words, the part of inflation that is externally driven, really is transitory. It’s OK to use the word transitory,” he said.

However, the former central bank governor says it takes time for that development to be reflected in the annual inflation rate.

Bank of Canada governor Tiff Macklem notably called inflation “transitory” – meaning temporary – when it first started rising.

Since then, he’s backed away from that characterization and has emphasized that the domestic economy is overheated and inflation won’t return to target without action from the central bank.

While high inflation has come to the forefront of economic policy discussions, many economists are concerned about what Canada is – or isn’t – doing to promote long-term growth.

During his speech, Poloz made the case for government policies that promote stability and clarity for businesses. The less uncertainty there is about trade policy and projects, for example, the more businesses will invest in their operations and improve their productivity, he said.

“Clarity is the obvious antidote to uncertainty.”

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