CANADA ECONOMICS FEATURE: CIBC Says BoC Can Always Find An Inflation Number To Fit Its Narrative
02:23 PM EST, 01/19/2024 (MT Newswires) -- "In the tug of war between a slowing economy and still elevated inflation, it is inflation that will eventually raise the white flag," according to CIBC's Benjamin Tal, who has sat in for Avery Shenfeld in writing the bank's regular 'The Week Ahead' column.
But, Tal asked, at what cost? -- noting the Canadian economy is "already in a per capita recession".
"The focus," Tal said, "will be on the speed at which inflation is getting closer to target. And yes, we can maintain until we are blue in the face that inflation is a lagging indicator, but at the end of the day, what really impacts the psyche of the Bank is the inflation du jour."
What index, Tal asked, is the Bank of Canada looking at to assess progress on the inflationary front? He noted the Bank's official mandate is to ensure that annual CPI inflation runs near 2%. But in order to achieve that target, the Bank zooms in on underlying inflationary pressures in order to avoid overreacting to temporary shocks.
"Between 1991 and 2001, life was simple," Tal said, noting the Bank focused mostly on core inflation defined as all items minus food, energy, and indirect taxes. Then in 2002, the Bank decided to improve its inflationary measure and introduced the CPIX, which excludes eight historically volatile CPI components along with indirect taxes. In October 2016, the Bank of Canada introduced three more measures that were judged to be more persistent and better correlated with the business cycle: CPI-trim, CPI-median, and CPI-common.
Between 2016 and 2020, Tal noted, the Bank was relying heavily on those three measures, but in April 2021 the first crack appeared. In its Monetary Policy Report (MPR), the Bank stated that, "Measures of core inflation have remained at or below 2% and have diverged since the first wave. Two measures -- CPI-median and CPI-trim -- likely overstate underlying inflation". And in July 2021, the Bank stated that, "Core measures of inflation have picked up in recent months, likely reflecting some of the same temporary issues driving movements in CPI inflation. CPI-common remains below 2%, while CPI-median and CPI-trim have moved above 2%."
"So," Tal said, "the assessment that the observed inflation at the time was "transitory" was based on the belief that CPI-common was a more reliable indicator. We now know that that was an error. Since then, the Bank has dropped CPI-common from its list of preferred inflationary indicators, but lately has been putting more focus on another inflation measure: services excluding shelter."
Tal added: "The point here is that when you have too many choices of preferred measures, that are themselves moving targets, things can get very confusing. Not only does the Bank look at no less than six indices, but also at any point, the focus can be on the y/y rate, the m/m rate, or smoothed versions of them. At this point following any CPI release, the Bank and the market have to look at no less than 30 inflationary numbers to come up with a narrative.
"So, you can easily choose your narrative and find the index that supports it, as was the case in 2021. A hawkish central bank might choose to focus on the squares with above 3% inflation, while a less hawkish Bank will focus on those with a 2% handle. In other words, the narrative will determine the data and not the other way around. Therefore, the tone of Governor Macklem's press conference will become increasingly more important than any new data releases because, at the end of the day, the Bank can always find an inflation number to fit its narrative."