The Straitjacket of Inflation Targeting: How the Bank of Canada Undermines Workers’ Bargaining Power

On Wednesday, Jan. 17, the Bank of Canada announced that it was raising the target for the overnight rate by .25 basis points, from 1.00% to 1.25%. With this adjustment to the overnight rate, the third rate increase in the previous six months, the Bank of Canada seeks to put the brakes on what has been seen by many as better than expected economic growth. Although, in late December, Stephen Poloz, Governor of the Bank of Canada, had committed to running the economy “hotter, so it uses up excess capacity that still is in the labour market,” it appears the recent data indicated the economy was getting a little “too hot.” While interest rates remain accommodating (serving to expand the economy), the intention of the hike is to nonetheless slow down the pace of economic activity. Although the bank pointed to increasing household debt-ratios and uncertainty regarding the future of NAFTA as causes for concern, it nonetheless justified this increase on the basis that intervention was needed in order to ward off future inflationary pressures arising from the economy reaching its “capacity limits.” The Steelworkers, however, are disappointed with the BoC decision to increase the overnight rate at this crucial moment; just as wages are beginning to (very moderately) increase and the benefits of economic growth beginning to “trickle down” to workers, after being flat for much of the “boom” in early 2017, this rate increase risks slowing or even halting that growth.

While economic growth in 2017, particularly through the first two quarters, was impressive, placing Canada at the top of the OECD, growing at a 4% annualized rate, it eventually settled down to a more modest, but impressive 3% for the year. Yet, despite this robust economic growth, wage growth was flat for much of the year. Although wages began to rebound in Q3, it was not until the next quarter that it accelerated, growing 2.9% until the end of the year and reaching a 2.7% increase year over year.


In late 2017, workers finally began to feel the benefits of economic growth as unemployment declined, labour markets tightened and wages were (finally) bid up. However, the generally associated increases in inflation – that sometimes, not always, results from higher wages – have been relatively mild. The monthly average inflation increase was just .02%. Until November, the yearly inflation rate average was only 1.4%. Only in November did the year-over-year inflation rate increase to 2.1%. Inflation then was well within the BoC’s inflation target rate of +/- 2%.

Given that both wage growth and inflationary pressures have been mild, a strong argument could be made to let the economy continue to run a little “hotter” so workers could benefit and see their wages progressively bid up. As the bank of Canada’s quarterly Business Outlook Survey found, 29% of employer respondents were planning to increase investments in productive capacity given the current “favorable demand conditions and capacity pressures.” This was the highest percentage since the Bank’s Q2 survey and it is an indication that employers are willing to continue to invest in their firms and expand capacity – buying machines, hiring workers – to meet the growing demand coming from consumers. This is good news for workers, as it maintains strong demand for their labour and increases their bargaining power, enabling their wages to be bid up. While interest rates remain accommodative, the bank’s decision, has the effect of dampening this growing consumer demand and potential business investment, as well as slowing down or even halting wage growth.

The rate increase brings to light the main issue: the BoC’s +/- 2% inflation target. For workers, this inflation target effectively functions as a straitjacket on their bargaining power and on their ability to increase their wages. The bank’s commitment to low inflation targeting, as opposed to pursuing full employment (a priority of the bank from 1945 to the mid-'70s, an era characterized by slightly higher rates of inflation, but full employment and rising real wages, the so-called “Golden Age”), means that the positive effects from the increase in workers’ bargaining power that derives from tightening labour markets – as a result of accelerating economic activity which gives workers some leverage and economic power and generally translates into sustained wage increases – is never fully realized. Just as workers begin to make wage gains, in comes the central bank under the guise of preemptive inflation-fighting to slow down the economy. In this way, by hiking interest rates and slowing economic activity, the BoC ensures that workers’ bargaining power is undercut, through attenuating the demand for labour, resulting in stagnating wage growth. At the same time, an increase in interest rates, while halting workers’ wage growth, functions as a pay raise to the banks, as they can now charge more for loans. This leads to further negative economic outcomes: as workers now see their interest payments increase, they reduce their consumption and divert their funds to servicing their debts. This diversion reduces economic activity and the demand for output, causing firms to scale back production, freezing hiring and productive investment and eventually laying off workers if demand slows down enough. This ultimately increases the pool of the unemployed, increasing the supply of labour in the market, and crucially, placing downward pressure on workers’ wages. 

In effect, the decision by the BoC reflects a tendency among central banks around the world to use monetary policy as a surrogate income policy. Through its excessively low inflation target, the bank ensures workers’ wages never increase too much, that they are just in line with inflation, making it very difficult for workers’ real wages and their living standards to increase. Not only is the commitment to inflation targeting bad social policy, as the economy never reaches a point of full employment, leaving a permanent oversupply of workers in the market who cannot find employment, it is also bad economic policy, as it serves to put a de facto ceiling on wages, therefore contributing to the increasing debt loads workers take on in order to finance their consumption.

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