Central Banks

Dealing with extreme uncertainty

A risk management approach helps the Bank navigate economic and political uncertainty, Stephen S. Poloz explained in a lecture that capped off his time as Governor. He also talked about how risk management applies during the COVID-19 pandemic.

The Bank’s risk management approach

Risk management is important for inflation targeting because there’s a lot about the economy that can’t be known with precision.

This doesn’t mean ignoring the sophisticated models that central banks use as a starting point for their forecasts and monetary policy decisions.

Instead, it means identifying the most important risks to the outlook for inflation and the economy and developing policies that will help make those risks less severe.

At times, this can mean being flexible with how long it takes to bring inflation to our 2 percent target—our main goal.

Recent years have brought extreme uncertainty about the global economy and political environment.

Tackling the biggest risks means we needed to change how we practise, and communicate, monetary policy:

We use more than one model, so we can cross-check what we’re seeing in the data.
We take the pulse of what’s happening in the economy by using “soft data,” such as consumer and business surveys and conversations with businesses and participants in financial markets.
We focus our communications on helping people understand what the Bank is doing, and why.

We need to communicate our assessment of the events and issues that are influencing our decisions, while being honest about the high level of uncertainty inherent in policy making.

Risk management and COVID-19

The COVID-19 pandemic brings a whole new set of risks and uncertainties.

How the labour market, business investment, and household, government and corporate debt evolve will depend on how long it takes to defeat the virus. And that’s the greatest uncertainty of all.

In the face of this uncertainty, our priorities are helping people and the economy and sticking with our inflation target. We do this by laying the foundation for a strong recovery:

We have cut interest rates to as low as they could go.
We have taken steps to support the financial system, so households and businesses can access credit and governments can secure funding for key relief programs.

Some worry that our measures will cause inflation down the road. However, the bigger risk is deflation, or falling prices, which is our immediate concern.

The extreme uncertainty from COVID-19 adds urgency to research that we and other central banks are doing to update and refine our risk management approach.