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A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.

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Oct 05 2017

BoC Will Struggle to “Normalize” Policy

On the heels of the strongest year-over-year (yoy) GDP growth since 2006, the Bank of Canada (BoC) hiked rates early last month for the second time in as many months. The output gap was widely invoked to explain the move; namely, even though inflation has clearly declined of late, economic growth has been above trend, which should theoretically boost inflation. However, the output gap has proven unreliable in the past.



Please recall that ECRI’s Canadian Future Inflation Gauge (CAFIG, not shown) has a lengthy real-time track record of anticipating cyclical turns in yoy Canadian CPI growth (chart). Conversely, as we showed for the U.S. in 2002 and again in 2011, the output gap is an unreliable indicator of inflation pressures, and may be misleading the BoC now, just as it misled the Fed before.

While the consensus expects Canadian inflation to move close to the BoC’s 2% target on the basis of the output gap, the latest update to the CAFIG clearly indicates whether such expectations are warranted. Without a cyclical revival in inflation – and  the recent uptick falls well short of a cyclical upturn – the BoC risks joining the world’s major central banks in their struggle to “normalize” monetary policy.

Related News & Events

Cyclical Forces Pressuring the Fed

CNBC September 20, 2017

ECRI’s Achuthan speaks with CNBC about how monetary policy is impacted by cycles in inflation and growth. More

 

Interview: Jobs, the Fed & Cyclical Developments

Reuters September 1, 2017

Economic growth, which has been ramping up since mid-2016, is now about as good as it gets. More

 

Finding the Root Cause of Recessions

Bloomberg August 25, 2017

Two things bear most of the blame: external shocks and economic volatility. More