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 morningâ€™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 todayâ€™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 Canadaâ€™s standard operating framework, a 0.25% target rate would have implied a target range from 0% to 0.5%. Todayâ€™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. Todayâ€™s announcement should end any remaining belief that the Bank of Canada can obviate the need for fiscal stimulus by fine-tuning interest rates.