Too Little, Too Late?

The Bank of Canada was right to reduce its target interest rate this morning, but it did not go far enough. The labour movement has been proposing significantly lower interest rates for at least a year. Even the C. D. Howe Institute’s conservative Monetary Policy Council, which was calling for an interest rate hike only three months ago, proposed a 0.5% cut this time. The Bank of Canada cut by only half that amount.

Unfortunately, the reduction may be less effective today than it would have been a few months ago. Indeed, it may not be passed along to Canadian borrowers. Concern that chartered banks would not match a 0.5% cut may have motivated the central bank to attempt only a 0.25% cut.

It is understandable that chartered banks are reluctant to lend in the midst of the credit crisis. But regardless of the interest rate, they retain discretion over which loans to make.

The real motive for chartered banks to not match the Bank of Canada’s cut may be to widen the spreads between the rate at which they borrow from the Bank of Canada and the rates at which they lend to Canadians. This is not only unfair to ordinary Canadians, but also severely undermines monetary policy. The Bank of Canada cannot manage the economy unless chartered banks follow its lead. At a minimum, political leaders should employ the power of persuasion to encourage them to do so.

If chartered banks require assistance from the Canadian state, it should not come in the form of wider interest rate spreads. The Government of Canada could instead purchase equity in chartered banks, as has been done in other western nations. This approach would give the banks additional capital and give Canadian citizens a share of future bank profits.

While banks are reluctant to lend at lower interest rates, Canadians may be reluctant to borrow. The credit crisis has damaged the economic confidence needed for households to make major purchases or for businesses to make major capital investments. This crisis has also cut the value of assets that households and businesses would use as collateral in seeking loans.

These factors could conceivably deteriorate to the point of rendering monetary policy ineffective. To stimulate the economy before it reaches that point, the Bank of Canada should have cut by 0.5% today. However, even if it had done so, monetary policy alone would not be enough. The Government of Canada should rebuild the country’s infrastructure, enhance Employment Insurance benefits, and invest more in other public priorities. Fiscal policy can stimulate the economy regardless of whether chartered banks are willing to reduce borrowing costs or of whether households and businesses choose to borrow from them.

2 comments

  • Yes Erin we have been on that one for such a long time now and I do agree that the discrepancy between the two rates is quite a real concern.

    Somebody is making money on he panic that has been holding the credit market hostage. If somebody who has legitimate credit request that now is charged a greater amount of interest for the same level of risk than say one year ago, it is pretty obvious that somewhere in the system, somebody will be making heaps of cash on these artificially high interest rates.

    I would have thought with all the extra intervention into the markets by the various government attempts at stabilizing the situation, people with less risky mortgage applications and such should be rewarded in these times and encouraged to spend.

    If it were purely markets without the government intervention than I could understand, but that is not the case. This leads one to conclude that the banks are basically holding monetary policy hostage for there own profit seeking motives, and when one starts eating there own, it comes back to haunt you in the end.

    But then again, what banks closets are not full of plenty of specters and ghouls.

    Just a random rant for the day.

  • Thanks Erin, I agree that this is a better step than letting the BofC drown in bank trash.

    But at the same time one cannot help thinking that the entire system is so completely backward, that we are pushing a rock uphill. We spend billions in banking props, take on their bad assets, let them continue to leverage the money we give them to ridiculous levels, starting the cycle all over again, while paying them interest on PFI/P3 infrastructure schemes.

    Why does the government not simply fund the needed projects directly? Through deficits and with the BofC partnering directly with municipalities?

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