By Jock Finlayson
What are we to make of the Bank of Canada’s recent decision to trim its short-term policy interest rate by another 25 basis points, taking it to a near record low level of 0.5 per cent?
The Bank is frankly acknowledging that the energy-related downturn in capital spending and exports in Canada has been greater in magnitude than it was expecting at the beginning of the year – and the pain is likely to persist. Canada is facing difficult economic adjustments stemming from a less rosy future for both oil and gas markets and those for many other commodities.
This is unwelcome news, as natural resource industries supply more than half of Canada’s exports and play a pivotal role in driving business investment in many regions of the country. A world of lower prices for energy and other commodities is a world in which Canadians can look forward to significantly slower growth in incomes than we enjoyed during the decade-long global commodity upcycle that began in 2002-03.
The Bank of Canada’s actions also speak to the reality that, at a time of considerable macroeconomic weakness, it has fallen on monetary policy to shoulder the burden of supporting aggregate demand. Fiscal policy is largely missing in action as the federal government – despite its strong balance sheet – prioritizes deficit avoidance, and several provincial governments struggle to contain escalating debt/GDP ratios. Given current economic conditions and Canada’s rather uninspiring near-term growth prospects, the existing monetary/fiscal policy mix seems far from optimal, at least at the federal level.
Finally, the latest cut in the central bank’s (already low) benchmark rate signals that the monetary policy tool box is now almost empty – at least in terms of “conventional” policy tools. A 25 basis point reduction in the bank rate is too small to have any appreciable macroeconomic impact, other than to put more downward pressure on our increasingly enfeebled currency. And with the policy rate set at 0.5 per cent, the Bank of Canada will have little capacity to respond in the event that the economy is hit by additional shocks. One can only pray that no nasty surprises lie ahead.
It is remarkable that, six years after Canada’s economy hit bottom at the tail end of the 2008-09 recession, the central bank’s benchmark rate sits perilously close to zero, and “real”, after-inflation market interest rates are negative (or nearly so) for bank savings accounts, GICs and some other fixed income products. Few Canadian forecasters imagined, circa mid-2009, that interest rates would remain at such exceptionally low levels a half decade or more into the future, particularly considering that Canada has posted several years of decent economic growth along with sizable gains in employment.
While the central bank is working with the tools at hand to deliver on a mandate centred on managing inflation, one can’t help but worry about the troubles being stored up as a consequence of year after year of rock bottom interest rates. Frothy housing markets and the accumulation of unprecedented levels of debt by Canadian households are the two most visible features of our present economic situation that have been aided by a long stretch of monetary stimulus. More generally, it is worth asking whether sticking with a macroeconomic policy framework that has encouraged leverage and borrowing on an epic scale while punishing thrift and prudence may be doing subtle but real damage to the long-term foundations of a productive economy.
Too large a fraction of the scarce capital and entrepreneurial talent in Canada has been directed into relatively less productive sectors and activities (housing-related investment, financial engineering, and consumer spending), while too little has been deployed to building the products, technologies, skills, enterprises, and infrastructure that Canada needs to be an internationally competitive 21st century economy. Perhaps such a misallocation of capital and talent is the price that must be paid in exchange for relying so heavily on hyper-accommodative monetary policy to sustain demand and spending in Canada during a period of sluggish global growth.
It is too early to render a firm judgement on how all of this will play out in the years to come. But policy-makers would be wise to pay a lot more attention to the downside risks inherent in today’s unbalanced Canadian economy in which consumers, businesses and governments have become used to the comforts afforded by astonishingly cheap money.
Jock Finlayson is Executive Vice-President of the Business Council of British Columbia.