(Bloomberg) -- Bank of Canada Governor Stephen Poloz said the nation’s economy carries plenty of untapped potential that allows policy makers to prolong an expansion without fueling inflation.
Poloz, in a speech Tuesday that focused on labor market slack, said the nation is at the “sweet spot” of the business cycle where growing demand is actually generating new capacity as companies invest to meet sales, a process he said the Bank of Canada has an “obligation” to nurture.
The increased investment, meanwhile, will help bring more people into the work force -- such as women, youth and the long-term unemployed. Poloz estimated there are currently about half a million Canadians who can be drawn into the labor force under stronger economic conditions, which could in turn increase potential output by as much as 1.5 percent.
“The bank has concluded there remains a degree of untapped supply potential in the economy,” Poloz said, according to the prepared text of remarks delivered at Queen’s University in Kingston, Ontario. “This is important, for it means that Canada may be able to have more economic growth, a larger economy, and therefore more income per person, without generating higher inflation.”
How quickly the economy expands without triggering inflation is one of the key questions the Bank of Canada is asking. The faster they believe it can run before overheating, the longer policy makers can afford to wait on raising interest rates. And Poloz’s comments seem to be leaning toward faster for longer.
Rate Outlook
The Bank of Canada has increased borrowing costs three times since July, but has taken a cautious stance on further rate adjustments. Investors are pricing in at least two more hikes by the end of this year.
“It should be clear that there are likely to be significant economic benefits associated with allowing the economy to find its way to a higher, more productive economic equilibrium, if this can happen within our inflation-targeting regime,” Poloz said.
It’s a controversial position. The economy is as close to full capacity as it’s been in a decade and the central bank’s conventional models are likely telling it to raise interest rates more quickly and aggressively.
Nor is it the central bank’s mandate. The Bank of Canada’s primary objective is to target inflation, not longer-term growth rates, and Poloz’s strategy is based on the premise that the erosion of productive capacity in recent years can be in part repaired. Inflation has been hovering near the bank’s 2 percent target in recent months.
“We expect to see increased investment -- both in existing and brand new companies -- as well as labor market churn create more supply through higher productivity and employment,” Poloz said.
Questions around the true level of the economy’s potential growth rate is one of a number of uncertainties the central bank is taking into account as it rejects a “mechanical” approach to policy and remains cautious on interest rates, he said.
“We cannot know in advance how far the capacity-building process can go, but we have an obligation to allow it to occur,” Poloz said.
The central banker cited a number sources of untapped labor market slack, including youth participation rates that still seem low based for this stage of the cycle. There is also scope to increase participation rates among women, Poloz said, citing policy successes in Quebec that helped more women enter the labor force. “The recent federal budget introduced some new measures in this direction,” he said.
Other Highlights
- Poloz did warn there remain downside risks to higher demand if supply doesn’t start rising. “These uncertain processes entail both upside and downside risks to inflation and our monetary policy remains particularly data-dependent as we balance those risks”
- Poloz also made a plea not to worry too much about technological advances, adding that historically they lead to higher productivity and living standards
- “The Bank can certainly use its monetary policy to help bring about a stronger, better functioning economy while still pursuing our inflation-targeting goal. This is particularly important in the current phase of the economic cycle, with demand prompting investment that can pull more people into the workforce.”
- Canada is seeing encouraging signs in data on new company formation -- the most potent form of business investment