How the Bank of Canada is thinking about interest rates now

Columbia Business School professor and economist Brett House joined us on Free Lunch this week to explain what was behind the Bank of Canada’s latest decision to raise interest rates, and how they’re thinking about the economic picture moving forward.

Why did the Bank of Canada decide to raise rates again last week?

“The Bank saw that core underlying inflation is still running at somewhere between 3% and 4%, and that's decently north of the 2% target that the bank has laid out for it. And it's accompanied by inflation expectations amongst businesses and households that also remain persistently above the 2% target. And so the Bank is trying to respond to both the reality of underlying inflation pressures that remain too high and those expectations.”

How much of the Bank’s rate hikes are about responding to expectations people have about where prices are headed?

“Inflation targeting has a strong psychological component to it. If the Bank talks tough, that generally is meant to bring expectations of inflation down. And if those expectations are contained, that self-fulfilling prophecy of inflation is less likely to come about. And a virtuous byproduct of that is that you don't have to raise rates as high as you might otherwise.”

Are we entering a more inflationary period generally, due to global factors beyond our control?

“We are almost certainly entering a world with more fraught trade relationships, less efficient production supply chains, more difficulty in sourcing some materials, and higher costs related to our green transition. But those higher prices may not continue increasing at a higher rate. They're not necessarily coming down, but the rate of increase in prices need not stay as high as it was last year at 8%. We may see inflation persistently at around the 2% target. it's worth remembering that in the 20 years leading up to the pandemic, inflation was persistently low in Canada. We undershot the target for a couple of decades on a consistent basis.”

This interview excerpt has been edited and condensed for clarity. Listen to our full interview with Brett House here.