What is the Bank of Canada's mandate and why is it so important?

Inflation in Canada through the post-pandemic recovery has surged to levels not seen in decades, forcing the Bank of Canada to take aggressive action to try to rein it in.

The price of virtually everything in Canada has soared through 2022. The Consumer Price Index (CPI) increased 6.8 per cent in April, with Canadians paying 8.8 per cent more for food, 7.4 per cent more for shelter, and 36.3 per cent more for gas.

The spike is something Canadians have not dealt with in decades, thanks in large part to the Bank of Canada's mandate, which is tied to the management of inflation and the economy.

So, what is the Bank of Canada's mandate?

The Bank of Canada's mandate is set by the central bank and the Canadian government every five years and outlines the objective of the country's monetary policy. As the central bank states on its website, "at the heart of Canada's monetary policy framework is the inflation-control target, which is two per cent, the midpoint of a one to three per cent target range."

The two per cent target was first introduced back in 1991, after a period that saw inflation become a serious problem, reaching more than 12 per cent in 1981. The goal at the time was to wrestle inflation down and reach the two per cent target by the end of 1995.

"To avoid the burden that inflation imposes on the economy requires a monetary policy that is firmly directed to reaching and maintaining price stability," the Bank of Canada said in its 1991 review.

"It is only with stability in the general price level that a sound basis can be provided for investment and lending decisions and the most effective use will be made of the economy's resources."

The Bank of Canada was successful in bringing inflation to that two per cent level, something it said "resulted in good overall economic performance."

Since 1991, price increases in Canada have averaged about two per cent. The target has also been renewed by each successive government.

Why is the inflation target two per cent?

According to the Bank of Canada, when inflation is close to the two per cent target, the economy is running near its capacity – meaning that demand for goods and services is roughly equal to what the economy supplies. When demand exceeds capacity, inflation can go up. If it's less than what the economy can supply, inflation can drop below that two per cent level.

"Over time, we have found that a target of two per cent promotes balance in the economy and growth that people can count on," the central bank said.

The latest Bank of Canada mandate review

The Bank of Canada's mandate was up for its five-year review in December 2021, and while the two per cent target remained unchanged, the government and central bank included new language around employment levels.

The government says the Bank's monetary policy should support "maximum sustainable employment," but that the primary objective must continue to be maintaining low and stable inflation. That means the Bank will have flexibility to stay within the one to three per cent range to seek "maximum stable employment," as long as medium-term inflation expectations are at two per cent.

Other central banks around the world explicitly focus on employment. The United States Federal Reserve has what is known as a "dual mandate" that has the goal of maximum employment and a low and stable inflation rate of two per cent per year. The Bank of England has a mandate similar to Canada's, with an objective "to maintain price stability in the United Kingdom. Subject to that, we support the Government's economic policy, including its objectives on growth and employment."

Bank of Canada criticism

The Bank of Canada recently found itself the target of scrutiny and debate in the wake of soaring inflation. Conservative leadership candidate Pierre Poilievre has been among the most vocal critics of the central bank, and says he would replace Bank of Canada Governor Tiff Macklem if elected prime minister.

The Bank has acknowledged that pandemic policies and inflation are testing the public's trust in the institution. Senior Deputy Governor Carolyn Rogers said in a speech in May that "there were some things we got wrong", pointing to persistent supply chain disruptions, Russia's invasion of Ukraine and China's renewed COVID-19 lockdowns.

"These are things we didn't foresee," Rogers said. "We know we have a ways to go before Canadians can fully judge the success of our actions."

With files from Bloomberg

Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.

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