Increased global integration impacts policy effectiveness: Poloz

Increased international trade is likely to make it harder for central banks to maintain policy targets, according to the BoC head

While international trade integration presents better economic opportunities, it may also come at an economic cost, according to a BNN report.

At a lecture at Western Washington University in Bellingham, Washington, Bank of Canada Governor Stephen Poloz cautioned that maintaining inflation targets may become more challenging for central banks as international trade becomes more integrated. Policymakers, he continued, must acknowledge this change and consider how to soften its potential impact on monetary policy decisions.

Citing model simulations run by the BoC, he said that increased integration can reduce economies’ sensitivity to exchange rates and make domestic inflation more dependent on international developments.

"Models that do not recognize rising integration are likely to predict that monetary policy actions will be more effective at stabilizing the economy and controlling inflation than they will prove to be in practice," Poloz said.

In a BoC simulation modelling high cross-border integration, it was found that more aggressive interest rate cuts were needed to cope with an economic shock. This supports the bank’s hypothesis that “a highly integrated global economy will make it more challenging for central banks to stabilize economic growth while pursuing inflation targets.” With that in mind, Poloz suggested that policymakers consider using complementary policy measures, or allow for greater flexibility in a central bank’s inflation objective.

The BoC’s current inflation target is 2%. In August, annual inflation dropped to a 10-month low of 1.1%. This comes against a backdrop of meager economic growth that followed the slump in crude prices and the Alberta wildfires.

The bank expects a second-half rebound, although it admitted earlier this month that lower-than-expected exports could take the economic profile below forecasts. Poloz reiterated during the question-and-answer session that the economy will take three to five years to restructure in response to lower oil prices.

Related stories:
Investors fear central banks can no longer stimulate economies
Poloz backpedals on Canada’s predicted recovery