Better Late Than Never

For several months, it has been clear that there is no near-term threat of inflation and that the economy needs all the stimulus it can get. In this context, the Bank of Canada should cut interest rates as far as possible. Since January, I have been calling for a target interest rate of zero percent.

We should applaud this morning’s announcement to cut interest rates as close to zero (0.25%) as the Bank of Canada was prepared to contemplate. We should also question why it dragged out this move over three scheduled interest-rate announcements even after the US Federal Reserve announced a zero percent rate in mid-December. This four-month delay seems difficult to justify given the speed with which output and employment have been declining.

A further advantage of today’s interest rate cut is that, other things being equal, it will tend to lower the Canada-US exchange rate. A lower exchange rate modestly improves the competitiveness of Canadian exports at a time when many manufacturing facilities are teetering on the brink of closure.

Under the Bank of Canada’s standard operating framework, a 0.25% target rate would have implied a target range from 0% to 0.5%. Today’s announcement indicates that the Bank will target 0.25% as the bottom of the range and 0.5% as the top of the range. This approach leaves central bank rates slightly higher in Canada than in the US, where the Federal Reserve is targeting a range from 0% to 0.25%.

In any case, the Bank of Canada has cut rates as far as it was willing to and has locked them in for a year. The monetary policy debate has now moved decisively beyond interest rates, placing the focus squarely on quantitative easing.

Reaching the end of the interest-rate road also puts the spotlight back on fiscal policy. Further stimulus spending will probably be needed. Today’s announcement should end any remaining belief that the Bank of Canada can obviate the need for fiscal stimulus by fine-tuning interest rates.

UPDATE (April 22): Quoted by The Toronto Star and interviewed on BNN

9 comments

  • I must say that today’s action was about as useful as one hand clapping. And that is about the extent of my praise for the BOC.

    Even in these times of capitalistic awkwardness, where not a one in power dares to admit or even contemplate that our current system is a failed entity. Barely a sweat has broken on their arroganct perspective.

    Of course this is how history is made.

    The only thing on the minds of the power’s that be, at least in our country, is bashing the labour movement. (wink wink, nod nod, amongst the elites as they sharpen their daggers for the CAW)

  • I must say I was enraged and amused when I heard that the Bank would keep rates that low “as long as inflation stays contained.” As if there is a single banker out there that is worried about 2% inflation creeping up to hyperinflation in this friggin’ environment. And let’s not forget the non-banker world, who don’t even notice inflation.

    What would people say if inflation started to creep up in the middle of a depression, and Carney actually increased rates? I think people would call for his head. And then Carney would be stuck saying “John Crow was right about things.” Then voters would have to reduce the tories to two seats (again).

    I don’t actually see this happening; I think Carney just had to blather about inflation much like Cheney had to go on about the threat of another terrorist attack.

  • All eyes will be on the Bank on Thursday when it releases the April Monetary Policy Report. There seems to be some buzz online that it will introduce some quantitative easing measures, so it should be interesting.

    Also, as Travis notes on his blog, the Bank has lowered its forecasts for 2009 and 2010. For 2009 they now see a decline of 3%, not the 1.2% they called out in January. Also gone is the proposition, that no one believed, of a bounce-back to 3.8% growth in 2010. The latest guess is 2.5%, but given their forecasting record over the past 18 months, I’m going with the dart-throwing monkey.

    http://rppe.wordpress.com/2009/04/21/bank-of-canada-beats-a-retreat-on-optimism/

  • In fact I asked the dart-throwing monkey what he thought about the BoC forecasting and he said:

    “Hey, look, forecasting is easy when you can take a ruler through low dispersion data points. Clearly we are out of equilibrium at the moment, but 3 years out from now and their ruler will work again I assure you.

    Mind you it is not just any old wooden ruler they have at the BoC, it is a special ruler with very little width so it can be bent a bit up or down, you, know, so like depending on what assumptions they make (pessimistic, optimistic or prozac*tm) they can adjust their line.”

    I asked if I could get a ruler like that and the monkey said: “nope, that is why I throw darts”

  • I believe the bendable ruler is an architecture tool. I saw a big blue one the last time I spent several hours loitering at a stationery store.

    The bendable ruler is not to be confused with that plastic box with the rods sticking out, where you press your face or hand into it, and the rods push through onto the other side with a perfect imprint of your face or hand. The latter tool is used by the finance ministry when they turn Fraser Institute research into government policy briefs.

  • Curses! You beat me to that title Erin! I was going to do a post with “Better Late than Never” as the title.

  • Thanks, Nick. This title so aptly describes Bank of Canada policy that I have used it twice recently.

  • With luck, really low interest rates will encourage over-indebted people to borrow some more, keep housing unaffordable, and build up our historically high debt to gdp ratio to even higher levels so that we can have another bubble which will pop with interest rates already at tiny levels, making the debt deflation problems even tougher to deal with than they have been this time around.

  • I like that red box thingy, how about the black box in Harper’s head, i.e. the one in which seemingly how the economy works- you know the one where this invisible hand inside teh black box, assures us all that everything will eventually be optimally allocated.

    The red box is also a pretty effective tool.

    More seriously though, I just about fell off my chair a few moments ago- and no it is not from the booze, – I don’t drink’- it was from Heather Scoffield’s article in the globe today on employment.

    Can you believe that she actually unpacked the R4- R8 unemployment measures for the media economists.

    I am just astounded!! I would gladly fall off my chair again should she continue on. I rarely praise media but Heather has just been elevated to leading media economist in my personal list- Derek D. though, your still on the bottom.

    http://business.theglobeandmail.com/servlet/story/RTGAM.20090421.wrjobs22/BNStory/Business/home

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