Better Late Than Never
The Bank of Canada got it right this morning in cuttingÂ the key interest rate by 0.75%. This bold action makes up for the timidity of cutting by only 0.25% last time. The central bank should be applauded for (finally) recognizing the severity of the economic crisis and going further than recommended by the C. D. Howe Instituteâ€™s conservative Monetary Policy Council.
Although the Bankâ€™s statement makes the obligatory references to “core inflation” and “the 2 per cent inflation target”, it refreshingly (if implicitly) acknowledges that the goal of monetary policy is now to provide economic stimulus rather than to manage inflation.
Of course, there are serious doubts about how much stimulus a lower interest rate willÂ deliver in an environment where financial institutions are afraid to lend while businesses and households are reluctant to borrow.
Fiscal policy could and should directly spur economic activity. However, since the Government of Canada introduced an Economic Statement with no new spending and then prorogued Parliament, there is no immediate possibility of fiscal stimulus. This makes it imperative for the Bank of Canada to do whatever it can through monetary stimulus.
Indeed, the federal governmentâ€™s surprising failure to announce any fiscal stimulus may partly explain the central bankâ€™s newly aggressive posture on monetary policy. Although the Bank of Canada would never overtly criticize the Government of Canada, todayâ€™s statement intriguingly refers to “fiscal policy actions” in an international context but not in a Canadian context.
The statement appropriately leaves open the possibility of “further monetary stimulus.” With the US Federal Reserveâ€™s key rate at only 1%, there clearly is room for the Bank of Canada to cut its rate below 1.5%.