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 Instituteâ€™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 Canadaâ€™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 countryâ€™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.