Central Bank Idles as Economy Sputters

This morning, the Bank of Canada left interest rates unchanged. It should have cut interest rates because Canada’s slowing economy and overvalued currency are more serious problems than the spectre of inflation.

Stimulus Needed

Last week’s Labour Force Survey indicated that Canada lost 39,000 full-time jobs in June, pushing unemployment to its highest level in nearly two years. Statistics Canada’s latest National Accounts show that real GDP declined rather than increasing in the first quarter of 2008. 

The Bank of Canada itself acknowledges “excess supply” in the economy. It should have lowered interest rates to stimulate the business investment and consumer spending needed to mitigate this economic downturn.

The Canada-US Differential

The Bank’s failure to reduce interest rates sufficiently has contributed to the excessively high Canada-US exchange rate. At the start of July 2007, central-bank rates were 5.25% in the US and 4.25% in Canada. Higher American interest rates gave international financiers some incentive to hold US dollars rather than Canadian dollars.

Today, central-bank rates are 2.00% in the US and 3.00% in Canada. Higher Canadian interest rates encourage international financiers to hold loonies instead of greenbacks.

Since July 2007, the Federal Reserve cut its target rate by 3.25% but the Bank of Canada cut its target rate by only 1.25%. To moderate the exchange rate, Canada must come closer to matching American interest-rate reductions.

Inflation Fears Exaggerated

The Bank of Canada’s unwillingness to cut interest rates, and calls for it to raise interest rates, are ostensibly motivated by concerns about inflation. However, the Bank’s preferred measure, core inflation, is running at an annual rate of only 1.5%, well below the Bank’s own 2% target. 

Today, the central bank indicated, “Core inflation is projected to remain well contained and broadly in line with earlier expectations, averaging close to 1.5 per cent through the third quarter of this year and then rising to 2 per cent in the second half of 2009.”

Even the total Consumer Price Index, which includes gasoline and mortgage costs, has barely surpassed the 2% target. While rising commodity prices will increase the cost of some goods, Canada’s cooling real estate market will dampen mortgage costs.

The Bank should push Finance Canada to more meaningfully reign-in mortgage lending. Reasonable mortgage-insurance rules would be a better tool than interest rates to moderate inflation.

UPDATE (July 16): This post is quoted in several newspapers today, including The Ottawa Citizen, Montreal Gazette, Vancouver Sun and Province.


  • The U.S. expects Canada to help it fix the U.S. current account deficit. Canada therefore is supposed to keep short term rates above those prevailing in the U.S. so as to maintain the value of the Canadian dollar. No competitive devaluation allowed. Of course we got away with that devaluation in the late 1990s. Now it is the turn of the U.S. to devalue, and its BIS Basle friends are helping out the adjustment process. Canada wants to be a big friend.
    My hope is that the Bank will hold interest rates stable, not go off chasing another imaginary policy target. At the moment the world financial system is in a delicate state. Some want to raise rates to squeeze out the bad loans, some want to lower them to advert recession.
    It is a lot to expect Carney to keep quiet, and do nothing. But in this case, its a whole lot better than another wild-eyed campaign against the bogeyman of the month.
    The Bank have never understood the extent to which in Canada interest rates are themselves inflationary, given the amount of capital investments that are financed at floating rates, or rolled over often. John Crow thought we were like London in the 19th century, where the central banks would raise rates 50 basis points and watch the price of tin, jute, cotton, sugar, tobacco, wine, etc. fall, as the cost of holding goods increased, and wholesalers liquidated stock.
    In Canada we have big cost huge investments in infrastructure spread across a continent, not London warehouses stocked with goods. Our rates go up, our costs go up. To make prices fall you have to engineer a recession.

  • Timothy Webster

    Duncan that is an excellent economic explanation. Except rates are not completely determined by the Bank of Canada.

    The Canadian export based economy is dead!
    And the Harper’s Conservatives killed it again. When did this last happen, yup when the Moroney’s Conservatives where in power. C

    Don’t quite get why the Conservatives feel kill the economy is a good thing.

  • It would seem that under Mr. Carny the BOC is about to come off its rails. Can you believe that they are projecting 4% plus inflation for 1stQ ’09. The substantive pressure coming from energy prices. I would say it is time the Canadian economy started untapping some of that western oil for ourselves and forget about the US. If our monetary policy is to keep the dollar at par, and use such shock therapy for our manufacturing sector, then it is time we developed another advantage. Cheap homebrew oil. I cannot understand why this is not considered an official policy option. Renegotiate NAFTA like the yanks want and repatriate our oil. There is a fair price that could be had for a barrel of oil to our porvinces out west, but at $140 you are only gong to destroy alot of wealth generation.

    Again shock therapy for the economy, going from $60 to $140 is ridiculously insane and it is not due to fundamentals. It is called speculation. Innovation will come regardless of price. Heck oil at $90 was enough for innovation motivations, this price level is beyond acceptable.

    Again the markets when left to the business world notions of regulation, will destroy everything and anything.

    Can you believe Carny flag waving for Harper today. These tories are libertarians all the way. I think Carny forgot about the notion that the BOC is supposed to be across the street from center block. Claiming that Canada’s economy is doing just fine, I thought was supposed to be Flaherty’s job. Quite appalling really. I hope they broadcast that to the industrial heartland.

    Time for some change, before these libertarians get the full throttle, they are starting to act like a majority party. Wait till a lot of these next waves of layoffs and de-industrialization that the tories along with the BOC has unleashed filters through the industrial value chain.

    We will then start feeling the squeeze more in the public sector and the economic disaster will be in full swing. By then it will be too late. Pretty much is already.


  • I also wanted to add that with the upcoming GDP report on Q2, today’s monetary report from the BOC with its positive GDP growth estimate was basically the BOC messenger pigeon to those out at the statcan barn that the GDP numbers had better not be in negative growth territory.

    There is a pivitol numbers game about to unfold at Statcan. If those GDP numbers come out in negative territory, it will begin the whole discourse of recessionary talk right through the economic and political culture.

    It will be very very bad for the tories. You can bet your bottom dollar every think tank, bank economist, right wing policy hawk will be out in full parade before those next numbers are released, stating how great the economy is doing.

    I know for a fact that the massaging that goes on with those GDP numbers is quite pathetic. I wonder how the new chief of statcan will react to this. I would say considering the fall off in the full time employment we have seen from the LFS and the dismall job reports over the past 4 months, that I would put my money on negative growth. But we will not see negative growth.

    This is due to the assumption that there is no political interference in the numbers coming from statcan and that my PEF friends would be a huge mistake for you to make.

    The transparency is not what you would think. The process is highly subjective, and although based on a bunch of modeling ultimately the numerical crunching process for GDP estimates is subjected to a lot of manual massaging. Many times the facade get paraded around as scientific, unbiased, Statistically significant and the rest of the culturally ingrained protocols.

    You can be well assured that the report today sent out by the BOC was basically the signal to statcan, you want to be following our lead. If those at statcan decide to go the other way with the numbers watch out, heads will roll.

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