The Battle against Inflation: The Bank of Canada and Its Critics

Abstract

The recent analyses of Canadian macroeconomic policies by Barber and McCallum (1980, 1981) and by Donner and Peters (1979, 1980) touch on a wide array of issues and hence have provoked an almost equivalent variety of comments and rebuttals. However, the central points of the twin pairs of authors can be expressed very simply: the monetary restraint policies of the Bank of Canada have been tried for over five years, they have failed to control inflation while simultaneously causing severe real output and employment costs, and therefore they should be abandoned in favour of some (not entirely clear) alternative approach. Unfortunately, the critics spend much more effort on laments about the poor economic performance of the last five years, than they do identifying in just what way the conceptual foundations of monetary restraint were flawed. The present paper argues that while the reductions in inflationary pressures have been disappointingly modest, the fault does not lie with the analytic and empirical arguments used to support the monetary restraint programs. The strategy of restraint was, and remains, sound. In particular, the critics have not demonstrated any good reason to reject the widely-accepted conclusion that a reduction in money supply growth rates was a necessary condition for any substantial lowering of the inflation rates prevailing in 1974-75. The policy failure has not been with the strategy of restraint, but with its tactical implementation. The apparent unwillingness to distinguish between the two issues has caused the critics to pursue many false issues and to advocate alternative policies that are simply untenable.