Bank of Canada governor Tiff Macklem is in a kind of limbo. He’s suddenly halfway through his seven-year mandate. It’s too soon to think about legacy, especially when the fight that will define it remains unfinished. The Bank of Canada’s latest forecasts have inflation at or near the two per cent target sometime in 2025. That means he should be able to start cutting interest rates this year. But he’s unsure when, never mind by how much. Inflation, at 3.4 per cent, remains too high for a central bank whose only job is to orchestrate price stability. And everyone knows what happens to heroes who dust themselves off too soon: they get pulled back into a fight by the villain who refuses to die. 

So, what does a central bank governor do at times like these? They can give speeches on the limits of monetary policy, as Macklem did Tuesday in Montreal. However, he respected his audience enough to come clean about the fact that he wasn’t offering anything new. 

“Full disclosure: every governor gives a speech about what monetary policy can and cannot do,” Macklem told the audience at an event for the Montreal Council on Foreign Relations. “Five years ago, my predecessor Stephen Poloz talked about the power and limitations of monetary policy, focusing on the difficulty of ensuring financial stability when your main job is price stability. Ten years ago, another of my colleagues, Mark Carney, observed: ‘Central banks are being simultaneously accused of being ineffective and too powerful.’ And early in the new millennium, David Dodge discussed the appropriate division and effectiveness of monetary and fiscal policies.” 

But just as Macklem is thinking about thinking about cutting interest rates, he’s also thinking about the themes he’d like to address once the inflation scare is over. One of those is Canada’s stagnant productivity growth, which, in an interview with The Logic after his speech, he called a “source of concern” before discussing the subject at length. 

The former dean of the University of Toronto’s Rotman School of Management has thoughts that anyone who cares about innovation will want to hear. We also discussed the surprising strength of the United States economy, how shelter costs are complicating the timing of interest-rate cuts and why he’s so opposed to raising the inflation target.   

This transcript has been edited for clarity and brevity. 

I thought I’d start with the U.S. economy. On a scale of one to 10, how surprised are you by the strength that we’re seeing in the U.S., which is something obviously that the Bank of Canada needs to pay close attention to? 

I’m not sure I can put it on a scale for you, but yes, we are surprised by the strength in the U.S. You saw another strong employment number last week. The PMIs all came out this week, a little stronger in general than the market expected. 

The U.S. consumer has been remarkably resilient. There are some reasons why that’s the case. Employment in the U.S. is strong. The unemployment rate is still close to a record low. Wage growth is solid. 

Where the U.S. really stands out is the strength of its productivity growth. That higher productivity growth pays higher wages without creating inflationary pressures. Their disinflation looks pretty similar to other countries, their growth trajectory has clearly been stronger. 

In virtually every other country during the pandemic, you built up what economists like to call “excess savings.” I’m not sure people see it that way, they saved money because they couldn’t get a lot of the things they wanted to buy. Americans have spent most of that [and] that has fueled their consumption growth. Canadians, on the other hand, actually have saved most of it. Our saving rate has gone back, but [Canadians] have either invested or banked their extra savings. 

We still think U.S. consumption growth, which is the core engine of the economy, is going to slow. Spending that extra pandemic savings may have delayed the effect of higher interest rates, but we still think they will bite. So, we do expect growth to slow, but yeah, we have been surprised and we could be surprised again. That is an upside risk to our [inflation] forecast. If the U.S. is stronger, there will be more demand for our exports and that is something we have to take into account.

I’m going to come back to a question that you’ve gotten a lot, and that’s about how you’re thinking about shelter inflation. If there’s nothing you can do about it, if it’s basically a supply issue, why not just look through it like you would any other supply shock?  

Our target is total CPI inflation. There are good reasons for that. CPI inflation is not a perfect measure of people’s cost of living, but it’s the best available cost of living measure. Our job is to have that cost of living going up two per cent. This isn’t just an academic exercise. Canadians are being really impacted by the rising cost of shelter. They’re talking to their elected officials, [and] governments are much more focused on this issue because they’re responding to what they’re hearing from their constituents. We’re hearing it from Canadians. You know, interestingly, when interest rates were at emergency lows, most of the letters I was getting from Canadians were about how that is juicing housing prices and making housing unaffordable. Now, we’ve raised rates a lot and most letters I get are about how our recent interest rates are making housing unaffordable. 

The thing that you have to take away from this is, yes, we’re not going to solve housing with low interest rates, we’re not going to solve it with high interest rates. But that doesn’t mean we can ignore housing. It’s an important part of the economy. It’s impacting Canadians. And we do need to factor it into our monetary policy decisions. 

The second thing I’ll stress is that we’ve built that into our forecast. You’ve seen our forecasts. We get back to two per cent inflation. We get back slowly. And one of the reasons we get back slowly is that shelter-price inflation is the major factor that’s holding inflation up right now. 

So, between now and the middle [of the] year, we’ve got inflation going pretty much sideways, around three per cent. By the end of the year, it comes down to two and a half, and then as you get into next year, we expect it to be at two. It takes a while. And an important reason why it does take a while is shelter-price inflation. And in our monetary policy report, we break down shelter and non-shelter inflation. And you can see they’re both coming down very gradually. 

There are some risks around that, you know, how housing responds. We’re not at the point yet, but when we get to the point where we’re discussing cutting interest rates, and we do cut interest rates, how does shelter respond to that? I think that is going to be a difficult thing to forecast. And keep in mind, housing is part of the economy. We’ve got to look at the whole economy, not just housing. 

But we factored it into our outlook. We do expect it to gradually come off, and we expect inflation in other components to gradually come off. 

The final point I would make is that our inflation problem is not entirely housing. Housing is the biggest contributor. But look at our measures of core inflation. That is stripping out the big increases and big decreases. So it’s stripping out most of housing, because they’re the big increases, but it’s also stripping out big decreases, things that are going down a lot. And when you do that, inflation is still around three and a half per cent. There are still underlying inflationary pressures in the rest of the economy. This becomes a bigger issue if those are gone and shelter price inflation is accelerating. That’s not what we have in our forecast.

If core inflation gets closer to two per cent and shelter stays elevated, would that be a condition under which you could start cutting? 

Ask me that question when we get there. 

One last question on this subject and then we can move on to something else. In an environment where much of the inflation pressure is coming from supply, and you’ve got productivity growth that is zero or worse, how does that affect your decision making? Because for as long as I’ve been paying attention to monetary policy, it’s been all about demand. 

You’re right, we talk more about demand, really for two reasons. One is, that’s what we influence with interest rates. Secondly, we have a lot more data, we have a lot more ways of observing demand than supply. Supply, our measures are more indirect. Productivity, as you know, is a residual. So it’s harder to get a really good handle on the supply side of the economy. 

Productivity is a concern, as you highlighted. Productivity growth has actually been declining for the last number of quarters. We have been surprised by that. We thought that as we came out of the pandemic, as supply chains improved, as new workers were trained and gained experience in their jobs, we’d see productivity pick up. We have not seen that yet. And that is a source of concern. 

We had an impressive boom in productivity in the second half of the 1990s with the internet. And unfortunately, it fizzled as we got into the 2000s. So we’ve had a good 20 years of weak productivity growth. And there’s been books written on this. 

What I find puzzling is that we actually have many companies across almost every part of the economy that are competing very successfully in global markets that are highly productive, that do invest in new technologies, that do invest in their employees. So the question in my mind is, “Why don’t we have more of them?” It’s not like we can’t do this. We can do this. We’ve demonstrated that. Why don’t we have more of them? And I think that is a difficult question. 

Competition’s got to be part of it. Because when you look at the data, export-oriented firms have higher productivity growth than non-export-oriented firms and export-oriented firms probably face more competition in the global marketplace. 

There are probably some structural barriers. We’re a very big country. We have more small- and medium-sized businesses, small- and medium-sized businesses don’t have as many resources to invest in new technologies. But still, we’ve had big businesses that start as small businesses which scale up to big businesses. So again, we’ve demonstrated we’ve done it, why can’t we do more? 

We’ve historically done a very good job of growing our economy by adding workers. And that’s both high rates of labour force participation—we’ve been impressed with the continued increases in female labor market participation—and then, of course, immigration. Canada is among the best in the world at bringing in highly productive immigrants, integrating them into the workforce. We’ve been very successful growing our economy that way. We have not been as successful on the productivity side. That is going to become important. Productivity just makes everything easier. As I’ve said many times, productivity pays for higher wages. Productivity is going to make fiscal decisions [easier]. It grows your tax base. It creates more fiscal room. It makes companies more profitable. It makes them more competitive. So getting focused on getting more companies that are winning in the global marketplace, I think is going to be important.

From where you sit, and from where you sat at Rotman, you must have had lots of time to think about this and talk to people about the productivity problem. What’s the one barrier that’s keeping us from creating more of those world-beating companies? Is it business investment? Or is it something else? 

This is really a whole speech. I think there’s a couple of elements. But I’ll admit, it’s a tough problem, and there’s probably no single solution. 

I think you’ve got to start with, what do we do really well? What are our strengths? You don’t become great by just fixing your weaknesses, you start by doubling down on your strengths. So what are our strengths? We’ve got a well-diversified economy with abundant natural resources, a good manufacturing sector and a large service sector. That diversification is a strength. We have a well-educated labour force. Our universities, our colleges—our education system is doing a good job of graduating well-educated people. You look at our rates of post-secondary education in Canada, they’re among the highest in the world. We’ve got talent. Companies are often coming to Canada to get that talent, because it’s here in Canada. That’s a strength. We’ve got to keep investing in education. What I love about education is, we often talk about the trade-off between efficiency and equality; in education, there’s no trade-off. Access to education is the best way to create opportunity for everybody and it’s a great way to grow your economy. 

Our universities are doing world-leading research in many new technologies. I’m speaking tonight with some of the global leaders of AI tonight, here in Montreal. We have a number of centres—AI, quantum computing, health sciences—[where] we’ve got world-leading scientists. Where we have trouble is transforming those innovations into world-leading businesses. 

So, I think part of it is: double down on your strengths. And then we’ve got to address some of our weaknesses. There are some obvious ones. We’ve got too many interprovincial barriers. We’ve got too many needless regulatory differences across the country. I mean, we’re not a very big market in global terms, [so] let’s make our market as integrated and as effective and as efficient as it can be. 

We need to make sure we’ve got the gateway investments to get products to market. We are seeing more issues with transportation backlogs that make it difficult to get products to market. And then finally, one of the things I hear a lot as I travel around the world—particularly in a world where security has become a bigger issue—many people, many businesses and foreign companies tell me, ‘I’d really like to invest more in Canada. North America is a fabulous market. You’ve got secure access through the USMCA, CETA, TPP to global markets. You’re a stable, well-governed country. Strong education system. But the regulatory approvals just take so long. I don’t know if I have the patience.’ And I think that’s something we’ve got to look at. We’ve got the essentials. If we can reduce some regulatory uncertainty, we can get more investment. 

The Bank of Canada doesn’t have part in this? And by this, of course, I mean the interest rate. I’m still struck by something I read in Paul Martin’s memoir, talking about his time in business. He said everyone talks about taxes, but for him, it was all about the interest rate. 

Well, I think we do have a role in reducing one uncertainty for Canadians, for businesses, for workers—and that is uncertainty about the value of money. Look, we have to use interest rates to control inflation. That’s the instrument that we have. I think there is a lot of confidence around the world and in the Bank of Canada. We have a long history of a well-governed, stable monetary framework. That is a source of confidence. That’s one of those fundamentals, that’s one of those cornerstones, those key building blocks. But to get back to my remarks today, there’s a lot more to it than that, and monetary policy can only do so much.

I feel I need to give you an opportunity to respond to something I keep hearing. And that’s that we need to raise the inflation target, or at least use the flexibility inherent in the band, instead of fixating on two per cent. Why don’t we do that? 

There are a few reasons. One is that our mandate is to achieve two per cent inflation. Secondly, if you decide that it’s not worth getting your target just because it’s difficult, you don’t have a target. You don’t change course just because you missed it. And I do think the two per cent inflation target has been a very successful anchor to the whole system. The confidence that we will bring inflation back to target anchors the whole system, and that plays an important role. 

You know, one version of this argument is, “Well, there were a number of forces that made it easier to hit the target in the last 20 years—expanding global markets, globalization and reduced price of many durable traded goods, demographics—and some of those things are reversing. We’re certainly not going to get the benefits of globalization, they’re not going to get replicated and they could even go in reverse. There are new costs from climate change. Supply chains are going to need to be more resilient, that’s going to add costs.” So, there is this argument that there are a host of new cost pressures that are here and are coming and so we should raise the inflation target. I think we need to take those arguments seriously. I think we need to have an open mind, but I have to say, I’m not convinced. 

Why not?

These are real things. Climate change is really happening. It’s really going to affect us. It’s really going to add cost. Security issues are real. Supply chains are going to have to be more resilient, and that’s going to require investment. Demographics are shifting. Those are things that businesses, households, the economy are going to have to adjust to. But is adding more inflation and more volatility [from] inflation, and the uncertainty that that’s going to create, is that going to help with that adjustment? I have a hard time seeing how adding more uncertainty—taking away your anchor—is going to make those real adjustments easier. 

I think we have a good framework in Canada. We review our target every five years. We will, as we have done in the past, do a review of our target leading up to 2026. And I look forward to that. This question is on people’s minds. We should look at this question. I don’t think it’s the only question. 

The other question that I think is going to be important, I’m sure you’ve noticed, we’ve been talking a lot about underlying inflation. We have a number of measures of core inflation. We had three, and [the CPI-common metric] really broke down. So we are now focusing on two. I think we do need to do a review of how we measure underlying inflation, core inflation, and make sure we’ve got the best available measures. Particularly in a world where we could have more volatility, we could have more supply shocks, getting the best available measures of underlying inflation, core inflation, is going to be important.

You’ve been doing a lot of things to try to ensure your message penetrates in more places by moving beyond traditional channels such as speaking primarily to markets and to people like me, and using social media and other paths to reach more people. Is that working, or is there still more to do? 

Well, awareness of the Bank of Canada has never been higher. (laughs) 

It’s a little hard to sort out. Awareness has certainly gone up a lot. Is that because our decisions are having such a big impact at the moment on Canadians or is that because we’re trying to communicate in more channels? There’s two elements. First, we have a responsibility to explain to Canadians our decisions. Part of that responsibility is to reach Canadians where they want to be reached. There’s no point in trying to communicate to somebody who’s not there, not in the room, not on the platform. So I do think we need to make a bigger effort to reach Canadians where they want to be reached, and when I say where they want to be reached, part of that is location, social media. Partly, it is at the level of detail they want. For many people, they don’t need the monetary policy report, they don’t want the monetary policy report. But they do need the broad strokes. People have to make financial decisions every day. They’re budgeting, they’re trying to stretch their budget. They need to understand: what are the big trends? What are we doing about it? So, reaching them where they want to be reached, and providing the information that they need. 

We’re a public institution, our decisions are impacting Canadians, we have a responsibility. I see the other part that you were getting at as sort of like the bonus. The bonus is, what we’ve seen is, the better people understand what we do, the better they understand our decisions, the more they tend to trust us. The more they tend to trust us, the more they have confidence that we will bring inflation back to target, the easier it is to actually get it back. I see that as a bonus. The first reason really is accountability, responsibility. If we get the second, great.

Kevin Carmichael is The Logic’s economics columnist and editor-at-large. He has spent more than two decades covering economics, business and finance for outlets including Bloomberg News, The Globe and Mail and the Financial Post, where he also served as editor-in-chief. 

Correction: This story has been updated to correct a transcription error that implied low interest rates were making homes affordable. It has also been updated to clarify wording that suggested the Bank of Canada targets the interest rate, not the rate of inflation.