Bank of Canada: Sometimes rate hikes needed even when economy is weak

The Bank of Canada is seen in Ottawa. THE CANADIAN PRESS/Justin Tang

The Bank of Canada, citing the potential for supply shocks to impose structural change, on Monday said sometimes rates needed to go up even when the economy was weak.

Deputy Governor Sharon Kozicki said that protectionist U.S. trade policies, Canada’s strained trade relationship with its neighbor and developments in artificial intelligence were structural changes that could lead to supply shocks.

“Many people may find it surprising or couterintutive that, at times, monetary policy needs to be tightened when the economy is weak. Yet that is exactly the difficult trade-off we sometimes face,” she said in a speech in Norway.

“Generally, when a supply shock is expected to have large or persistent impacts on inflation, some degree of policy restraint will be needed to bring inflation back to target.”

Kozicki said none of what she was discussing formed part of the bank’s current monetary policy deliberations. She also did not mention the U.S. and Israeli attacks on Iran.

The BoC will announce its next monetary policy decision on March 18, where it looks set to keep the key rate unchanged at 2.25 per cent, the level it says should keep inflation close to the two per cent target as long as the bank’s forecasts hold true.

Kozicki said rising risks from geopolitical tensions, an aging population and frequent extreme weather events were also leading to more supply-side shocks.

“Supply-side developments can lead to trade-offs for monetary policy. And sometimes, these developments can result in a combination of a weak economy and high inflation,” she said.

When a supply shock is expected to have large or persistent impacts on inflation, some degree of policy restraint will be needed to bring inflation back to target, she said.

But when a supply-side shock has less impact on inflation but weighs on economic activity, the BoC is less likely to tighten policy and might actually ease it, she added.