Global Investment Outlook
Our quarterly Global Investment Outlook is now available in written and video form, including an economics section with the title “Surveying the post-election landscape”.
2025 outlook recap
The previous #MacroMemo from December 17 laid out 11 key economic themes for 2025. As a brief refresher, these are:
Sustained economic growth – Recession appears to have been avoided.
Vibecession to fade – Things aren’t quite as bad as people feel, but they should start to feel better, too.
U.S. exceptionalism persists – The U.S. economy has a good chance of outgrowing its peers, again.
Animal spirits unleashed – The U.S. election has induced a surge in confidence about the economy, whether fully justified or not.
Tricky inflation – Inflation can likely continue to decline, but it has become more stubborn recently and the scope for improvement has diminished somewhat.
Slower rate cuts – With solid growth and the aforementioned tricky inflation, there is notably less room for rate-cutting ahead, especially in the U.S.
“No landing” scenario on the table – While not the most likely outcome, a “no landing” in which the economy overheats has become more plausible. It replaces “recession” as the second most likely outcome (see next graphic).
Macro scenarios for U.S. are in flux – soft landing still most likely, but recession no longer next most likely
Tariffs, but how much? – Tariff threats are front and centre in 2025, though it remains unclear just how aggressively these will be pursued. We budget for moderate tariffs, but there is the risk of more, even if only temporarily.
Chinese resilience – That hardly describes the Chinese economy today, but we think the country’s exposure to U.S. tariffs is smaller than imagined and the potential for further stimulus is greater than imagined.
Geopolitics in focus – There is a lot happening on the geopolitical front. The new U.S. administration could yet shake things up, with difficult-to-predict consequences.
Choppy Canada – The Canadian economy is set for an unusually bumpy 2025 with potentially large (and highly uncertain) headwinds including U.S. tariffs and sharply slower population growth, contrasted against potentially large tailwinds highlighted by a lower overnight rate and faster productivity growth.
U.S. political considerations
The 119th U.S. Congress was installed on January 3, with a Republican majority in both chambers. President Trump along with the rest of his Executive Branch will join them on January 20. Mike Johnson was re-elected as House Speaker, defying earlier concerns that it would be difficult to secure a consensus regarding the role.
We’ve already speculated extensively about the potential course for U.S. public policy in the weeks and months ahead. In brief, tariffs and immigration are likely to be first on the agenda, with government spending cuts, deregulation and tax cuts expected to be implemented somewhat later. But none of this is certain. An omnibus bill that delivers many policies at once cannot be ruled out.
The precise timing and magnitude of all of these actions remain in doubt, with high tariffs and large-scale deportations a serious economic danger. But more muted versions of these policies are most likely, and potentially compatible with fast U.S. economic growth so long as tax cuts, deregulation and animal spirits are sufficiently forceful.
Quite a lot will become clearer immediately after the inauguration, as the Trump White House plans to move quickly. What follows are a few supplemental thoughts that build upon our prior analysis here and here.
Spending cuts
On anticipated spending cuts, these are likely to be fairly small, falling well short of talk of the targeted US$2 trillion in annual savings.
Some context is useful. Out of approximately $6.75 trillion in total annual federal spending, “mandatory” spending alone combines for $4.1 trillion or 61% of the total. This includes Social Security, Medicare, Medicaid, Affordable Care Act subsidies, food stamps, welfare, child tax credits, veterans’ benefits and government pensions.
Tack on $882 billion in interest on the public debt and the amount that remains unaccounted for – theoretically spanning the government’s “discretionary” expenditures and thus areas that might be considered ripe for consolidation – sums to less than the targeted $2 trillion in savings.
This isn’t completely fair as the government could theoretically opt to scale back mandatory programs such as welfare, child tax credits, the Affordable Care Act or Medicaid. However, many of these are popular and empirically effective. Realistically, programs such as Social Security, Medicare and government pensions are probably off-limits.
Individual programs have scope for cost savings, to be sure. But as the Wall Street Journal recently reported, a program such as Medicare that spends $12 billion on administrative costs is actually as much as 12 times cheaper per unit of health care provided than equivalent programs administered by private insurers.
On the other hand, it might be harder to achieve significant savings within the discretionary programs than commonly imagined. Of the approximately $1.75 trillion in total discretionary spending, defense outlays capture slightly more than half. The Trump administration, while isolationist, has not shown an inclination to significantly reduce military expenditures. In Trump’s first term, the government actually increased military spending.
The salaries of civil servants are often regarded as ripe for cost savings, but at just $271 billion in total annual expenditures (just 4% of the federal government’s total expenditures) and with more than 60% employed by the military or security-related functions, the scope for fixing the budget via government layoffs or wage reductions is more limited than frequently imagined.
Individual programs have scope for cost savings, to be sure. But as the Wall Street Journal recently reported, a program such as Medicare that spends $12 billion on administrative costs is actually as much as 12 times cheaper per unit of health care provided than equivalent programs administered by private insurers.
Tariffs
The threat of tariffs continues to be best thought of as a negotiating tactic for the Trump administration to extract concessions from trading partners. We do expect an increase in actual tariffs, but of a targeted nature from both a geographic and a sectoral perspective, and with the view that most countries will manage to negotiate down the magnitude of the impact on their industries.
The post-election threat of a 25% tariff on Canada and Mexico has clearly been tied to border control, as a prominent example.
More recently, Trump expressed dissatisfaction with how the British government administers its North Sea resources, advocating for the country to dismantle its wind turbines in the area and to make the area more conducive to further fossil fuel investments. The latter part of this could yet be a condition for the U.K. to minimize American tariffs.
More broadly, there has long been the widespread expectation that Trump will pressure countries to spend at least 2% of their gross domestic product (GDP) on defense, in line with NATO targets. That represents a stretch for some countries including Italy (1.5% of GDP), Canada (1.3%), Spain (1.3%) and Germany (1.2%), but is nevertheless achievable over time and not unreasonable in the context of elevated geopolitical tensions.
[T]he point is that there will be considerable pressure to increase military spending, and not by a small amount.
However, Trump recently escalated his military demands, arguing that countries should instead spend a massive 5% of their GDP on defense. No NATO country does this, with Poland currently leading at 4.1% of GDP. Even the U.S. only spends 3.4% of GDP on its military. As such, it is right to be skeptical about this specific number, but the point is that there will be considerable pressure to increase military spending, and not by a small amount.
To the extent military spending does increase among American allies, whether motivated by White House demands or geopolitical realities, the cascading implications include:
Increased demand for the wares of arms manufacturers.
Incrementally higher employment among the young, less skilled and male segments of the labour force.
An unclear effect on whether the likelihood and intensity of wars rise (more military might) or fall (greater deterrence).
As American allies fortify themselves over time, there could theoretically be scope for the U.S. military to shrink as it will no longer have the same “global policeman” obligations. But the threat of a more militarized world and a variety of other forces (competition with China, political considerations in Congressional districts with military bases or related industrial facilities, and rapidly changing military technologies) could keep American defense expenditures high.
In principle, if national governments are spending more on their militaries, the classic guns versus butter tradeoff means that governments must sacrifice other objectives such as social programs, or subtract from the private-sector economy via taxation, possibly reducing the scope for productivity gains. Then again, military technologies have famously underpinned some major civilian technological advances.
On a different tariff-related note, China remains the primary theoretical U.S. target. We have written in the past about how China’s exposure to U.S. demand is smaller than one might think, with the result that tariffs should not hurt too badly (limiting Chinese access to key American technologies and resources is another matter, though two can play at that game). Illustrating just how diversified Chinese exports are, nearly half of the country’s foreign sales are to fellow Asian nations, a further 20.7% goes to Europe, and a cumulative 15.1% goes to Latin America, Africa and Oceania. That leaves just 15.9% of Chinese exports headed to North America, and that includes not just the U.S. but Canada, Mexico and the continent’s other, smaller nations (see next chart).
Further, it goes without saying that the great bulk of China’s economic output is consumed domestically. All of this trade collectively captures just 19% of the country’s output – which is how North America consumes just 3.0% of Chinese economic output and the U.S. specifically consumes just 2.5% of the total.
China exports mainly to Asia
(12-month rolling sum, % of total exports)
Debt ceiling
The threat of a U.S. government shutdown was averted in the early hours of December 21 when Congress belatedly passed the necessary legislation, funding the government through March 14. Set your calendar for another hard-fought decision then, though one under a united Republican government reduces the degree of difficulty.
However, the matter of a rapidly approaching debt ceiling remains outstanding (see next chart). Soon-to-be-ousted Treasury Secretary Yellen indicated that the Treasury Department will have to resort to extraordinary measures beginning in the middle of January given a massive deficit that reached $1.84 trillion in fiscal year 2024. As prior such episodes have demonstrated, financial juggling and accounting tricks can fend off technical default for several months.
U.S. about to bump into debt ceiling again
A U.S. debt default is ultimately quite unlikely. But the debt ceiling is nevertheless relevant for two reasons:
The subject will shortly come into focus, creating political stress and possibly market perturbations. Bond yields increased during the most angst-ridden moments of prior encounters with the debt ceiling. Overall Treasury yields rose during the 2015 debt ceiling showdown, whereas it was primarily Treasury securities expiring on or just after the expected default date that saw higher yields in 2023 (with risk aversion tending to drive the yields on other Treasury securities downward in that episode).
There may be consequences for overall economic liquidity. Counter-intuitively, once the government has to resort to extraordinary measures, the amount of money sloshing around the economy goes up. This is because the government has historically opted to fund itself in stopgap fashion via the Treasury General Account, which currently has $677 billion in it. This can be thought of as the government’s chequing account. Under normal conditions it is desirable to maintain a fairly large balance so as to comfortably handle the large and lumpy outflows that the government is regularly obliged to pay. But when borrowing in the bond market is no longer available, this account is allowed to run down. That takes money that is normally sitting idle on the government balance sheet and pumps it into the economy. As a result, many believe the economy runs temporarily hotter during such periods. However, when the debt ceiling is later lifted the money gets sucked back in as bond issuance picks up.
For his part, President-elect Trump appears not be a fan of the debt ceiling, arguing it should be abolished altogether. We concur. Congress already gets to indirectly control the size of the public debt via spending and taxation bills. These recurrent flirtations with technical default are unhelpful from bond-yield, debt-rating and policy-predictability perspectives.
North American employment preview
U.S. payrolls for December will be released this Friday, with a +135K consensus forecast. With the caveat that there is a considerable amount of volatility associated with these releases, we’ll take the over. The rate of economic growth in the U.S. is consistent with at least that much monthly hiring, and there should be a small further bounce-back from the hurricanes two months prior. We may also see a small tailwind from the late timing of Black Friday, which allowed retailers to hire holiday workers after the last survey reference period, meaning they should appear in the December rather than the November data. The unemployment rate should remain roughly unchanged at 4.2%.
In Canada, the consensus is for a 25K job increase in December, which is roughly in line with the average of the past six months. Slower immigration represents a downside threat, as does the outsized increase in employment the prior month. But these numbers are famously skittish, so almost any number is possible.
Stubborn U.S. inflation in perspective
Inflation remains more challenging in the U.S. than in most peer nations (see next chart). The current U.S. Consumer Price Index (CPI) print is +2.7% year-over-year (YoY) for November, and the country is tracking a 2.9% YoY performance in terms of the average price level in 2024 versus 2023. Greater U.S. inflation pressures arguably make sense given the country’s lesser interest-rate sensitivity, large fiscal deficit, superior economic growth and tighter labour market.
RBC GAM Consumer Price Index forecast for developed markets
Despite this, we continue to believe there is some scope for the U.S. inflation rate to ease in 2025, even if the result is set to remain higher than target and above those of most other developed nations.
A small aside: it is also worth reflecting on the fact that the Federal Reserve (Fed) and the U.S. economic community generally prefer the Personal Consumption Expenditures (PCE) deflator over CPI to gauge the rate at which American consumer prices are rising. Attractively, the basket of goods and services in the PCE deflator is broader than that for CPI. The PCE deflator also adjusts more dynamically to changing consumer preferences.
As it happens, the current U.S. PCE deflator is just +2.4% YoY (versus +2.7% YoY for CPI). The core PCE deflator is at +2.8% (versus +3.3% for core CPI). Those are 0.3 and 0.5 percentage point undershoots, respectively (see next chart). This doesn’t mean that U.S. inflation is suddenly lower than in other countries – those other countries would also benefit from a switch to a PCE deflator methodology. But it does mean that the U.S. isn’t as far off its 2.0% target as one would otherwise surmise.
The gap between the two core inflation metrics is also larger than normal right now (the norm is more like 0.3 percentage points). This argues that core inflation is not quite as troublesome as it first looks, even if you understand that CPI generally runs hotter than the PCE deflator.
U.S. Consumer Price Index tends to run hotter than PCE deflator
But before we go arguing that the Fed can therefore cut rates more aggressively, note that – as with the CPI readings in recent months – the PCE deflator metrics have also stalled out in their improvement, and even regressed over the past few months. So there remains the pressing need for U.S. inflation of all stripes to begin declining again before we can talk seriously about significantly more Fed rate cutting.
Modest economic concerns bubble to surface
The economic trend has been more good than bad over the past several quarters. But it would be fair to concede that the pace of growth may now be waning slightly.
For both the U.S. and the world, economic surprises have retreated from positive territory back into a slightly negative space over the past few months (see next chart). This is still perfectly fine. But the point is that economic data is no longer consistently delighting relative to expectations, even if the latest Institute for Supply Management (ISM) Manufacturing print looked pretty good relative to its recent standards.
Economic surprises have dipped below zero
On a similar note, the closely watched Atlanta Federal Reserve GDPNow model, which attempts to forecast U.S. quarterly GDP in real time, has also staged something of a retreat in its fourth-quarter 2024 tracking. From a peak forecast of +3.4% annualized growth on December 11, the anticipated number has since declined to +2.4% annualized as of the data released on January 3. That’s still respectable, but less red hot than the earlier trendline. The economy expanded by +3.0% annualized in the second quarter and by +3.1% in the third quarter.
In China, the world’s other mega economy, concern has recently been expressed about the pace at which Chinese bond yields are falling (see next chart). This is definitely worth watching given broader economic concerns about the country. But we don’t believe it suggests there has been a sudden collapse in China.
Chinese bond yields drop to record low
China’s economic surprise index is actually slightly positive right now. The country’s Caixin Purchasing Managers’ Index (PMI) Composite is still roughly in line with the average of the past year (and consistent with economic growth) at 51.4.
Instead, we would point to several other forces that support low bond yields. Chinese inflation remains virtually non-existent, up just 0.2% YoY. GDP growth, while still materially positive, is undeniably running slower than the norm of the past several decades. It is tracking at +4.6% YoY for 2024 and a bit less again in 2025. In other words, with Chinese nominal GDP growth running at its slowest rate in many decades, it makes sense that Chinese bond yields are doing the same.
We also continue to flag the potential for significant economic stimulus in the months ahead. This includes further rate cuts, which the bond market is now pricing in via lower yields. Tack on a bit of risk aversion within China given the threat of U.S. adversarial actions, and the current low yields are not a complete mystery.
The point is that we don’t believe declining yields signal a rapid downshift in the pace of Chinese economic activity. Whether such low yields are fully justified and can be sustained is another question – they do seem pretty low, even relative to the admittedly subdued pace of nominal Chinese GDP growth.
Recession signals in flux
The 12-month rolling risk of a U.S. recession has fallen beautifully, from greater than 50% in the latter half of 2022 and over the bulk of 2023, to just 15% today. The thematic logic for this is that central banks are cutting rates, the inflation (and monetary policy) shock is fading into history, and economic growth has serially exceeded expectations. There is now the prospect of supportive fiscal stimulus.
Our recession scorecard reaches the same conclusion. The number of recession indicators signaling “Yes” is down to just four out of 15, and the number of “No’s” has risen to six (see next table). For comparison, as recently as November 2023 there were seven “Yeses” to just one “No.”
Our scorecard shows recession risk falling
The latest indicator to abandon “Yes” is the U.S. Conference Board’s leading indicator. It recently staged a tentative rebound after nearly three years of decline (see next chart). You can argue this merits an outright “No” rather than the “Maybe” we assigned, but it would be nice to see another few months of recovery before making the full leap to “No.”
U.S. leading economic indicator rose slightly in November
Of the four indicators that continue to blink red, all are subject to some debate.
Historically, a material increase in the U.S. unemployment rate has presaged recession, and the usual threshold for this has – just barely – been exceeded. But, unlike most historical episodes, the employment rate never fully kept pace, and for that matter the unemployment rate now appears to be trending roughly sideways, violating the historical trend of incessant increases once the pattern has begun. As such, we stick with the “Yes” for now, but there will come a time when the “Yes” may have to be abandoned if the unemployment rate continues to go sideways.
That leaves the other three recession indicators, all pertaining to different segments of the yield curve (see next chart). It has historically been a good recession predictor when yield curves invert (longer term yields that fall below shorter-term yields). But the recession doesn’t usually actually start until the yield curve then un-inverts in bull steepener fashion (yields falling due to economic concerns, with short-term yields falling faster than long-term ones due to mounting rate-cut expectations).
We’ve now seen one of the three yield curve segments un-invert, and the other two have nearly done so. But this is being accomplished via a bear steepener (yields up) rather than the customary bull steepener. Markets cannot be said to be pricing in weaker growth and more aggressive rate cutting. That arguably invalidates the recession signal, but we feel an obligation to stick with the “Yes” generated by the recently inverted yield curves for somewhat longer, as frequently they presage a recession from many quarters away.
Yield spreads rising across all three measures
While the recession signals are clearly increasingly tilting toward “No”, the global trade input needs to be watched as it may be at risk of tilting from “No” to “Yes” (see next chart). Global trade is presently rising, which is good, but there are obvious risks in the immediate future as protectionism mounts. Of course, if global trade were to retreat on higher tariffs, that would constitute a less problematic recession signal than normal. Weak trade is usually an amplified reflection of a broader economic malaise, whereas in this instance it would be trade weakness unrelated to other economic issues (though the trade weakness, of course, can contribute to a weaker economy).
Global trade is reviving
Federal reserve backs off
The Federal Reserve’s December 18 rate cut took the fed funds rate down to the 4.25-4.50% range. That represents a cumulative 100 basis points of easing from the peak policy rate last summer.
Realistically, the Federal Reserve is now on a slower easing path ahead. Even with a few recent wobbles, the U.S. economy is fairly strong and inflation has been stickily above target in recent months. The Fed recently upgraded its 2025 inflation forecast by nearly half a percentage point.
The language of the Fed’s latest statement highlighted the “extent and timing” of additional adjustments. It suggested rate cuts should no longer be counted on at every scheduled meeting, and also that the end of the easing cycle could be coming into sight. One voter preferred not to cut at the December meeting at all, and another three non-voting participants similarly preferred to leave the fed funds rate unchanged.
The market now expects slightly less than two further 25-basis-point rate cuts by the end of 2025. This would leave the fed funds rate just below 4.00% (see next chart).
Fed to cut interest rates cautiously
For our part, we have a slightly greater three rate cuts forecast by the end of year. This is not so much due to any clever thought about the economy faltering or inflation stumbling, but more because we continue to think a neutral policy rate is substantially below 4%, and realistically closer to 3%. Thus, there may be opportunities to reduce rates by a bit more than the market thinks, simply because a significant amount of restraint may no longer be necessary.
And if that thought proves premature for 2025, perhaps due to a U.S. economy that remains warm even at year end, it may be a useful thought for subsequent years. It is striking, as per the chart above, that markets apparently think the fed funds rate never falls below around 4%, not merely in 2025 but also in 2026 and 2027. It would be unusual if the policy rate never descended to a truly neutral reading of 2-2.5%.
A second thought pertaining to the chart is that market expectations have gyrated pretty extraordinarily over the past year. The light blue and gold lines represent some of the most stimulative and hawkish expectations of the past year, accordingly. The implication is that, going forward, market expectations could yet change significantly – and perhaps repeatedly – before 2025 is through.
As expectations swing about the central bank outlook and the economy more generally, a useful rule of thumb may be that if the U.S. 10-year yield ascends beyond 5%, it signals markets are pricing in a “no landing” scenario. Conversely, a reading below 3.5% may point to a hard landing. We continue to favour the “soft landing” scenario that perches between these two extremes, with the view that yields can descend modestly from current levels.
U.S. yields remain in soft-landing mode
Canada in focus
The Canadian political, policy and market environment remains notably busy.
Canadian political change underway
It has long been known that Canada will host a federal election at some point in 2025.
Now, adding to the intrigue, the incumbent Liberals will also have to select a new leader. Prime Minister Justin Trudeau announced on January 6 his intention to resign. He will continue to head the party until a new leader can be chosen. The Liberal Party constitution requires a leadership vote to typically occur within five months of a leader’s resignation, though there is some flexibility built in.
The leadership race won by Trudeau in 2012-2013 took seven months to conclude. Today, there is some urgency for the Liberals to select a new leader, as a federal election must be held by October 2025. Furthermore, tariffs and other policy matters will shortly need to be negotiated with Trump. In light of this, the Liberal Party’s autumn 2008 transition may be illustrative, as the pivot from Dion to Ignatieff required a mere two-month leadership campaign. A further parallel is that the global financial crisis at the time required serious political decisions, even if the Liberals were the opposition party then.
Parliament has been prorogued until March 24, which means that the government will not sit between now and then, and any bills that have not yet been passed into law have been terminated.
Canadian political polls – which admittedly precede the recent Trudeau bombshell – have the opposition Conservative Party continuing to extend its remarkable lead, and the Liberals at risk of falling behind the NDP (see next chart). Barring a sharp change in voter sentiment, a majority Conservative government remains likely whenever an election is called.
The Conservative Party’s lead widens
A winter 2025 election is no longer possible given the prorogation. A spring election is most likely as all three major opposition parties have promised to oppose the Liberal minority government. However, there is a chance the Liberals strike a deal with another party – most likely the NDP – delaying the election until the fall.
We continue to believe the Conservative Party’s economic platform is somewhat more supportive of productivity, economic growth and businesses than the current policy mix (see next table and a discussion in an earlier #MacroMemo).
Comparing the Liberal and Conservative platforms
Loonie below 70 cents
Although news of Trudeau’s resignation has added nearly half a cent to the Canadian dollar, it remains at this writing just below the symbolic 70 cent threshold (0.6961 / 1.4365) and considerably weaker than a few months ago (see next chart).
Canadian dollar weakness in long-term context
By no means is this the weakest the Canadian dollar has ever been (see next chart), but it is nevertheless the softest since brief moments of extreme stress in 2020 (pandemic) and 2016 (oil shock, dovish monetary policy). The last time the currency spent any significant time at this valuation or below was 1998—2003.
Canadian dollar weakens
In the short run, the distinct risk is that the currency could be a bit softer yet given questions around tariffs and a still-dovish Bank of Canada.
But we continue to think markets may be in the realm of peak pessimism about Canada (see that thesis here). In turn, it is unlikely the Canadian dollar remains this soft indefinitely or falls substantially further. Fair value from a purchasing power parity standpoint is closer to 85 cents (0.85 / 1.17), though no one seriously expects the currency to approach that level in the near or medium term.
In the meantime, do not forget that a currency acts as a useful shock absorber. In Canada’s case, the country’s productivity woes can be partially offset by competitiveness-enhancing currency weakness, keeping the economy moving forward even when other forces conspire against it.
Bank of Canada rate cut
The Bank of Canada opted for another big 50-basis-point rate cut in December. This took the overnight rate down to just 3.25% – a full 175 basis points below its 5.00% apex. It later admitted that the decision to move by 50 basis points rather than by 25 basis points was a close call.
With a 2.0% inflation rate, an unemployment rate that has increased from 4.8% to 6.8% over the past two years, and significant mortgage rollovers in 2025 and 2026, it is not unreasonable to expect some additional monetary easing. A 25-basis-point rate cut on January 29 is a reasonable expectation, and we look for the policy rate to settle at 2.75% later in the year. There is arguably downside risk to this, as Canadian economic conditions could justify outright monetary stimulus rather than merely diminished restraint.
Canadian GDP growth is tracking a negative print in November, though admittedly after an outsized gain in October.
Looking for clues in the Bank of Canada’s mandate review
Every five years, Canada conducts a formal review of the Bank of Canada’s mandate. This often provides useful insight into what is on the mind of the global central banking community.
In 2011, the Bank of Canada considered price-level targeting, whereby an inflation miss in one direction would be made up for with an inflation miss in the other direction to keep the overall price level rising at a predictable 2% per year on average. Despite some highly attractive qualities, this was ultimately rejected. For it to work, it would require economic actors to actively expect low inflation in the future whenever inflation was high, and vice-versa, whereas the natural instinct is to expect more of the same (if with decaying force over time). Absent this behaviour, getting prices back down would require a deep recession, and getting prices up after an undershoot would require seriously overheating the economy.
Later, in 2016, the Bank of Canada gave serious thought to raising its inflation target, reflecting concerns of that era about getting stuck at the zero lower bound and being unable to stimulate growth without the help of a larger inflation buffer. This was also rejected.
In 2021, bucking the normal “evaluate but reject” pattern, the government actually tweaked the Bank of Canada’s mandate, instructing it to pay somewhat more attention to employment and economic stability as it seeks to achieve its inflation goals. Within the definition of “flexible inflation targeting,” this fell somewhat short of a formal dual mandate, but nudged the central bank in that direction.
In the lead up to the expiry of the current mandate on December 31, 2026, the government now appears to be focusing on:
Whether to change how the Bank of Canada makes decisions, presumably with an eye toward shifting from a consensus-based approach to a voting system (perhaps with a larger pool of participants), and toward greater overall transparency. Many central banks have already done this, and this seems reasonably likely to happen in Canada.
Whether to shift from flexible inflation targeting (recall, the approach in which inflation is the target but employment and economic considerations should be factored into that calculus) to a proper dual mandate that also formally targets the labour market.
Whether the Bank of Canada’s core inflation metrics – CPI-Trim, CPI-Median and CPI-Common – remain the best options for monitoring underlying inflation. It seems very likely that some changes will occur here. The Bank has a history of switching indicators, as CPI excluding eight volatile items was the country’s preferred core inflation metric before being swapped out in 2016. Additionally, the central bank has already significantly backed away from CPI-Common due to flaws that were exposed under the harsh lights of the recent inflation shock.
Without a clear sense for the precise direction, additional core inflation metrics could enter the mix. Examples include variations that prioritize certain particularly illuminating segments of CPI (such as “supercore CPI,” which recently gained popularity as a measure that digs into the relative black box of core inflation setting aside shelter costs). Or, the Bank could adopt more exotic and novel metrics, such as “maximally forward-looking inflation,” which uses modelling to optimize the weights in the price index to better predict future headline inflation.
Within all of this, there is nothing that argues monetary policy should become substantially more hawkish or dovish. However, one could construct a slightly flimsy argument that paying greater heed to unemployment could encourage central banks to be slightly more dovish as there is always the temptation to argue that the sustainable unemployment rate has structurally declined, allowing low rates even as the economy tightens. Central banks made precisely this mistake several few years ago.
Maybe the most important takeaway from the announced mandate review is that price-level targeting did not come up, despite the massive political temptation to find a way to undo the damage of the leap in prices that took place over the past several years. In our view, there just isn’t a way to do that without inflicting massive economic damage. Central banks likely have the same attitude.
-With contributions from Vivien Lee and Aaron Ma
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