Does the Public Get a Say on Interest Rates?

Canada is in the midst of a housing crisis – the average cost of a house has risen to over $700,000 while the cost of renting has also skyrocketed. The country is also facing inflation with a high of eight percent at one point and food prices that keep increasing. After years of very low interest rates, and in response to rising inflation, the Bank of Canada has raised interest rates eight times since April of 2022. While inflation has fallen, it still persists, and the Bank has not reached its target of two percent. With the cost-of-living problem and the worry that Canada might enter (or is already in) a recession, some politicians have called on the Bank not to raise interest rates further. Nevertheless, economists have expressed worry about the political influence on the central bank. Is it appropriate for politicians to attempt to influence monetary policy in this way?

Something of a controversy emerged at the end of August when British Columbia Premier David Eby issued a plea to the Bank of Canada to pause any potential rate hikes. With the rate now at five percent and inflation still present, there was concern that further hikes were on the horizon. In a letter to Bank of Canada Governor Tiff Macklem, Eby pleads to consider the “human impact” of increasing rates again and claims that unnecessary increases would pose a danger to both homeowners and renters. The Government of Canada and the Bank of Canada have had an agreement since 1991 that the Bank would commit itself to an inflation target of two percent, and Macklem has been firm in insisting on hitting that target: no more and no less.

In response to this unusual public plea from a politician to the central bank, some economists are expressing frustration. UBC Okanagan associate professor Ross Hickey has called Eby’s move a “reckless act.” The appeal jeopardizes the impartiality, independence, and non-partisanship of the bank.

We don’t want our central bank to respond to politicians at all, it’s independent. It’s akin to the Supreme Court of Canada, we don’t want the Supreme Court of Canada to be responding to what politicians say in letters … we want the Bank of Canada to follow its mandate to pursue keeping inflation at a target of two percent per year.

Hickey is adamant that asking a justice to change their decisions to suit an appeal on various people’s behalf would be wrong. As Hickey describes the move, “I understand you’re independent, but I still want you to do something for me, that’s gobbledygook.”

The situation became more nuanced when the Conservative Premier of Ontario, Doug Ford, issued a letter of his own five days later similarly calling on the bank to halt hikes making it difficult for people to make ends meet. Having entered into a black-out period prior to rate change announcements, the Bank did not respond to either letter. Nevertheless, when the announcement did finally come, the Bank held interest rates steady. There is no evidence to suggest that these appeals had any effect on the Bank’s decisions, and the federal government has placed almost the entire onus for dealing with inflation on the bank, not wanting to get involved in the issue. But is Hickey right that it’s wrong for politicians like Ford and Eby to make such an appeal?

Typically, a lot of importance is assigned to central bank independence and on maintaining inflation targets. These targets reassure people and businesses that they can make long-term financial plans. Central bank independence from political leadership aims to ensure stability by preventing political interference favoring short-term considerations. If the independence of the central bank is undermined, it could erode confidence, creating financial instability. Given this, Hickey may be right that public pleas from politicians are a bad idea.

On the other hand, so much of this argument hinges on how we understand the concepts “independence” and “risk.” First, let’s respond to Hickey’s analogy about the justice system. There are, in fact, ways in which you might indicate to an independent judge what you would like them to do and still have the court retain its independence. They are called courtrooms. Nothing about appealing to a person or making one’s preferences known inherently subverts independence. In fact, governments are often granted “intervener” status in court. If I ask a judge to not convict someone of a crime before they make their judgment, it doesn’t stop the judge from coming to their own decision. So long as I cannot override the judge or imply that I will fire them if they do not decide what I want, their independence need not be threatened. Independence does not imply that you cannot appeal to people as they make their choice, it just implies that at the end of the day, the choice is theirs to make. The same is true of the central bank and the case of these Premiers. There is no way for either Premier to exert any direct influence.

Second, Hickey’s point that we don’t want central banks to respond to politicians at all is inherently self-defeating. The two-percent target only started as part of an agreement in 1991, having shifted from an initial five-percent aim. The two-percent target as a long-term goal was only standardized after 1998. That target has been renewed several times, as recently as 2021 where the government gave additional leeway to consider employment as they consider how to meet their goal. Central banks, then, should have to respond to concerns of the public; they are not above reproach, and to suggest that a central bank should not have to respond to public concerns is undemocratic.

But while the bank can set a target, we can still have public discussions about how best to achieve that aim. Central banks are not above reproach, and it’s undemocratic to suggest that economic policy is not a public issue. Some economists, for example, have criticized the federal government for leaning so heavily on the central bank and interest rates to solve the problem. Indeed, this is the point that Eby’s letter was attempting to make. The bank’s actual mandate, for example, requires a target of 1-3% inflation over “the medium term.” There is no hard-and-fast rule for how fast the target must be met. Given this, it’s not even obvious that Eby and Ford were asking the Bank to act against its mandate. As there are different ways to measure inflation and different assumptions involved in making inflation projections, political debate seems necessary. It should not be the case that the central bank’s methodology or approach for fulfilling their mandate are beyond the public’s purview.

There are, for example, reasons to question the assumptions that underpinned inflation targets in the 1990s and whether this strategy should be used to fight inflation today. Unlike the 1990s, inflation is not the result of decades of rising wages. Instead, it is the product of global politics – such as the war in Ukraine – and, more significantly, supply chain issues caused by the COVID-19 pandemic. These new factors may mean we need to approach the present situation differently. Surely there is some way to adopt temporary changes to monetary policy without the sky falling. Some, for instance, have floated the idea of temporarily adopting a three-percent target. Economists, meanwhile, balk and continue to decry “political interference.”

Still, there are reasons for thinking that economic policy requires political oversight. Ultimately, comments like Hickey’s and others’ exemplify a technocratic mindset that undercuts democratic discussion by relying on the assumptions of experts that remain closed off from public scrutiny.