Bank of Canada's Poloz: 'We Know How Inflation Works' -- Update

By Paul Vieira Features Dow Jones Newswires

Growing worries in economic circles about a broken relationship between growth and inflation in the developed world have been "greatly exaggerated," Bank of Canada Governor Stephen Poloz said Tuesday.

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Inflation in a number of advanced economies has run short of expectations, leading some policy makers and economists to worry about the ability of central banks to manage inflation and inflation expectations.

Mr. Poloz's speech at a luncheon in Montreal offered a defense of central bankers' understanding of the current dynamics affecting prices. He also dismissed concerns the link between economic growth and inflation has been altered, due to factors such as an increasingly integrated global economy and the advent of the digital economy.

"The popular perception that inflation has become inexplicable has been greatly exaggerated," he said, according to his prepared remarks.

In Canada, total inflation slowed over the first half of 2017 after reaching a peak of 2.1% in January even while spare capacity was shrinking rapidly and the country was posting the fastest pace of growth among Group of Seven economies. In recent months, price pressures have firmed, with annual inflation accelerating in September to 1.6%.

Mr. Poloz said the bulk of the slowdown in Canada is attributed to below-average food inflation and the province of Ontario's decision to lower electricity bills for households. He added there also may be "some drag" related to globalization and digitization. "The bottom line is that the fundamental drivers of inflation, along with some special factors we can identify, can explain the recent behavior of inflation reasonably well," Mr. Poloz said. "We know how inflation works. The laws of supply and demand have not been repealed."

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Mr. Poloz helped design the Bank of Canada's inflation-targeting regime in the late 1980s, which aims to set rate policy to hit the midpoint of a 1% to 3% range. That regime was renewed in 2016, with the central bank introducing three new measures of core inflation to get a better grasp of underlying price pressures.

Inflation-targeting central banks tend to lower interest rates to help prices adjust whenever demand falters. If there is risk that excessive spending pushes inflation over the target, central banks tend to raise rates to cool growth.

The central bank raised rates twice this year, in July and September, on faster-than-anticipated growth. But in its latest decision issued last month, the Bank of Canada's governing council struck a more cautious tone, keeping rates unchanged and arguing that slack remained in the labor market and it wanted to get a firmer grip on how indebted households responded to higher rates.

"A lot of pieces need to fall into place before we can be certain that the economy has made it all the way" to full capacity and 2% inflation, Mr. Poloz said. The central bank expects annual inflation in Canada to reach the 2% target in the second half of 2018, or later than originally anticipated.

A pickup in inflation can have positive effects on an economy. It might prompt consumers to buy goods and services before prices head even higher. Further, it provides flexibility to firms to offer wage increases to employees, thereby giving consumers more income to spend.

Write to Paul Vieira at paul.vieira@wsj.com

(END) Dow Jones Newswires

November 07, 2017 13:41 ET (18:41 GMT)