March is too soon: The Bank of Canada should use its flexibility to support the recovery as long as possible
Many investors and analysts have been suggesting that central banks should start removing policy accommodation sooner rather than later to fight the increase in inflationary pressures. However, given the nature of the shock, the decision for central banks will not be so easy. Their levers influence demand, and most of the upward pressure on prices is coming from issues with supply.
However, the recovery from a flood is inevitably bumpy. Shortages occur because demand never went away, while supply was disrupted, creating a mismatch. But within weeks, economic activity will have recovered and returned to normal. The COVID crisis is the same, only bigger and longer . The frictions that naturally come with a recovery from a natural disaster are therefore broad-based and stubbornly persistent.
Similar things are happening across the global economy. So it is important to think about how an economy reacts to a demand shock versus a supply shock. The difference in the way each type of shock affects the economy will influence the way central banks react.Article content
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