E The Bank Of Canada’s Uncertainty Principle

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For those familiar with quantum mechanics there is the famous Heisenberg uncertainty principle. In layman's terms, the principle states that is a limit to what can know about atoms. One can know the atom’s position, but not know about its momentum, or one can know its momentum or speed but not its position. Both are not possible to know at the same time.

Now for the certainty

The Bank of Canada issued its policy statement today and to no one’s surprise left its bank rate unchanged at 0.25%. In addition, it announced a cut back to its bond-buying program. The bank in rather certain terms came out with a firm GDP growth forecast for 2021 and 2022. The Bank’s growth outlook is now forecasting 6.5% in 2021 and 3.7% in 2022, an upward revision from its forecasts made earlier in the year. The Bank sees a much better start to the year and does not anticipate any slowdown, despite announcements by Ontario and Quebec on Covid-induced restrictions. Accordingly, analysts are anticipating that the timeline for rate hikes has moved up to the second half of 2022. There are many bank economists who expect good news on growth and employment that would lead to an increase in the Bank rate. On the question of inflation, the Bank expects a temporary spurt which will, nonetheless, fall within the Bank’s policy range of 1-3 %. The Bank expects CPI inflation to ease back toward 2 % over the second half of 2021 and to continue to be held in check at 2% in 2022.

 Now for the uncertainty.

The Bank relies greatly on measures of potential GDP to gauge the appropriateness of their policy decisions. The Bank has revised upwards its estimate of potential output in light of the economy’s performance in early 2021.  However, at the same time, it acknowledges that “the virus and lockdowns have had very different impacts across sectors, businesses, and groups of workers, creating an unusual degree of uncertainty about the amount of slack in the economy and how long it will take to be absorbed. {italics are mine}. In other words, the essence of good policy making lies in knowing where the economy is in relation to its potential. Judging that relationship is virtually impossible when COVID is dictating economic conditions---- the Bank has no influence of how the virus will affect who is open for business and who is employed. Thus, there is great uncertainty regarding how long it will take the economy to recover.

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Norman Mogil 2 weeks ago Author's comment

I think we're all flying at night with instrument panels.