OTTAWA (Reuters) - Bank of Canada Governor Mark Carney dismissed the idea on Tuesday of the central bank targeting employment as well as inflation in its mandate, as the U.S. Federal Reserve does, saying that trying to do both can backfire.
Nonetheless, Carney - a front-runner to head the Financial Stability Board, a global bank regulator - did say there might be a need for more flexibility to take broader financial stability into account when the Bank of Canada sets interest rates.
The bank and the federal government are examining whether to expand or adjust the central bank's role as they craft a new five-year mandate for it, which will start in 2012.
"History has shown that if you try to directly affect things like the unemployment rate, as it turns out it has a negative effect on both inflation and employment, and this is in fact what happened in the 1970s," Carney told the House of Commons finance committee.
The left-leaning opposition New Democratic Party said last month that the finance committee would look at whether the Bank of Canada's mandate is broad enough, and whether factors such as employment should be considered.
The bank's only target under its current mandate is an annual inflation rate of 2 percent, with a control range of 1 to 3 percent. By contrast, the Fed has a dual target of low and stable prices and maximum employment.
"The unemployment rate has been lower since we targeted a certain rate of inflation," Carney said. "If you look at other indicators, including the health of financial markets, the health of the labor market, we believe that these figures have improved with our targeted inflation rate."
The main argument for targeting both jobs and inflation is the risk that blind pursuit of stable inflation could lead to unacceptable unemployment rates.
Proponents of an inflation-only target say that a central bank can be torn in two directions and end up losing credibility if, for example, it allows prices to rise too fast in the pursuit of more employment.
Carney said that, since it was brought in in 1991, inflation targeting has proven its worth in both tranquil and turbulent times. "Even so, we are always looking to improve the framework."
The bank has studied three possible changes - revising the inflation rate that it targets, switching to price-level targeting and giving monetary policy a bigger role in ensuring financial stability.
It appears set to change little other than to explain how it may be flexible with the timeline for bringing inflation to target if confronted with financial instability.
When asked to comment on Tuesday, Finance Minister Jim Flaherty said only that the bank's mandate would continue to be controlling inflation.
"We'll deal with the range when we announce the agreement," he said.
Carney has increasingly advocated taking financial stability into account in setting monetary policy, suggesting that monetary policy should be used as a last resort in this case.
Currently, for example, that would mean the bank could look at whether to take action on rising house prices to avoid the dangers of a bubble, even though it forecasts overall inflation will be lower than its 2 percent target for most of 2012 and 2013.
"What we have favored is very good regulations, micro regulations starting with the Superintendent of Financial Institutions," he said. "Secondly, selected macro prudential tools such as the government has used in the mortgage market.
"And then, only after those have been used to their maximum impact, if there is a generalized issue, then there may be a role for monetary policy to play within a flexible inflation targeting framework."
Additional reporting by Louise Egan; editing by Peter Galloway and Rob Wilson