Bank of Canada Governor Stephen Poloz’s 1982 Ph.D thesis — “The Demand for Money in a Multicurrency World” — generated three separate journal articles, an uncommon achievement that helped him win a job at the central bank straight out of university.
Poloz is wrapping up his professional career the way it began.
The governor, who will retire when his term ends in June, has been spending considerable time at a keyboard, churning out an uncommon amount of academic analysis for someone whose day job comes with a full daily calendar. Last month, Poloz published a paper that argues that the embrace of artificial intelligence (AI) is leading a so-far-undetectable productivity boom.
This week, he supplemented that idea with a second paper that will hopefully be passed around in Ottawa, the provincial capitals, and as many C-suites as possible in the weeks and months ahead.
We tend to be overly occupied with short-term issues and can miss the big, slow-moving forces that are coming at us
The new paper is based on remarks he made in September at the annual Spruce Meadows Changing Fortunes Roundtable, a discreet gathering of carefully selected members of the global elite in Calgary. Poloz imagines where Canada could end up years from now as digital technology, protectionist politics, and unprecedented levels of debt converge to generate forces that will be unfamiliar to executives, investors and policy makers. The point of the exercise is to suggest that the future should turn out fine, if different, provided we don’t get hung up on what Barack Obama might call “stupid shit” along the way.
“This topic reflects my concern that we tend to be overly occupied with short-term issues and can miss the big, slow-moving forces that are coming at us,” Poloz wrote in the new paper. “By exercising the muscles of understanding alternative projections, we can build the ability to adapt to whatever comes our way.”
Poloz reckons executives and investors should prepare an extended period of suboptimal policy.
He told reporters after a speech in Toronto this week that the “actual finalization and the ratification” of the new North American free-trade agreement is “crucial” for restoring business confidence and investment. The backing of the Democratic majority in the U.S. House of Representatives and the subsequent signing of an updated agreement this week was positive, but the process chilled investment for the better part of two years. And unlike most trade agreements from the postwar era, the new NAFTA restricts trade, instead of making it broadly freer.
If this is the template for dealing with the world’s largest economy, then it’s reasonable to predict that the growth rates to which we had accustomed during the most recent phase of globalization will no longer be possible. Therefore expectations should adjust accordingly, as some growth is better than none at all.
By way of example, Poloz mentioned “hurdle rates,” the return on an investment that executives require to justify the risk of deploying precious capital. “Companies that are still working with hurdle rates from 10 years ago will find fewer investment opportunities that exceed those rates,” Poloz wrote.
“The implication is that companies need to adjust hurdle rates downward to reflect the new reality and then seek ways to manage elevated risk besides.” If they don’t, “lower investment spending means slower economic growth now, and it means that the economic potential of our economies will grow more slowly over the long term as well.”
Poloz has bought into the notion that we are in the early stages of an industrial revolution akin to the eras created by the steam engine, electrification, and the computer chip.
It does challenge the persistent notion that we’re due for a downturn just because that’s the historical pattern
The previous three industrial revolutions ended in misery, as euphoria over the possibilities fuelled asset-price bubbles that brought calamity when they burst. But Canada’s central bank governor is a techno-optimist. Even if some professions vanish, overall employment always trends higher. He also observes that policy makers have been getting better at managing the economy; the third industrial revolution (computer chips) ended with the Great Recession, a terrible outcome, and yet an improvement on the depression of the 1930s.
Poloz said central banks and others have studied the mistakes of the past few decades and have adjusted their approaches accordingly. That doesn’t mean there will never be another big recession, but it does challenge the persistent notion that we’re due for a downturn just because that’s the historical pattern.
If Canada’s economy crashes in the near future, it probably won’t be because the central bank raised interest rates too high, too fast
If policy mistakes were the trigger for previous recessions, and policy makers have learned how to limit such mistakes, then it’s conceivable the current expansion could extend longer than those that have come before.
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In Poloz’s previous paper, he said the productivity gains from AI should allow central banks to leave interest rates relatively low for longer because inflation will remain contained. That would help cushion the bumpy transition to a new economy. In other words, if Canada’s economy crashes in the near future, it probably won’t be because the central bank raised interest rates too high, too fast.
A more likely cause would be debt. At almost 180 per cent of disposable income, Canada’s household debt will be a vulnerability for a long time, “arguably for a generation, or at least until mom and dad leave behind their real estate and savings to help millennials pay off their debts,” Poloz said.
The burden is manageable, as servicing costs are reasonably low. Still, the weight of it could cause voters and their elected representatives to seek ways to lighten the load. Poloz warned that a renewed tolerance for inflation could emerge, something for which markets appear ill-prepared. “We should at least consider the possibility of a confluence of incentives between indebted households and indebted governments to tolerate another inflationary episode” like that of the late 1970s and 1980s, Poloz said. “Financial markets appear to be attaching very low weight to this risk today.”
Poloz stressed that he could be wrong about where the arc of history is headed. But his thinking makes for a good frame for Bank of Canada policy. Canadian policy makers surprised many on Bay Street by leaving interest rates unchanged this year as almost every other central bank cut. One reason for the disconnect appears to be that the central bank is taking inflation more seriously than investors.
And yet Poloz has sent a clear signal that he’s comfortable letting the economy run a little hotter than rules designed for a pre-revolutionary economy might allow. In a way, he’s showing us we needn’t fear the future. Call it a parting gift.