The Bank of Canada outlined a position Monday that says its economystimulating policy interest rate may remain well after the country is producing at full capacity, earlier estimated to be in mid-2016.
Senior Deputy Governor Carolyn Wilkins, in a major policy analysis and declaration, told financial analysts in Toronto that the Bank estimates that the nominal neutral interest rate has dropped to between 3% and 4% from 4-1/2% to 5-1/2% in the mid 2000s.
That estimation balances the effects on the economy not only of the continuing hangover from the global financial crisis but of domestic matters such as Canada’s aging population, serious household debt, workers having left the labor force and businesses slow to invest.
The BOC’s four-year-old 1.0% policy rate, Wilkins noted, “relative to this longer-term concept of neutral …. is stimulative.”
She added in the speech’s central message: “We need this stimulus to close the output gap and maintain inflation sustainably at target” (2.0% for headline and core CPI).
“But even with a closed output gap and inflation at target, the policy rate may not be at neutral,” Wilkins warned. “As long as the factors leaning on growth persist, a policy rate below neutral would be required to maintain inflation sustainably at target.”
“In the absence of this policy stimulus, the output gap would re-emerge and inflation would fall below target.”
Wilkins said that some of the headwinds facing the Canadian and global economies appear to be dissipating, “but there is considerable uncertainty about how long they will persist.”
She noted that the debt of advanced economies taken together doubled from about 160% of GDP to 320% between 1980 and 2010, “and will take a long time to unwind.” She thought the global savings rate, in fact, would increase over the next five years.
The Bank is weighing the Canadian risks to financial stability posed by continuing low interest rates, she said, adding that, the Bank has “made it clear that household imbalances are at the top of our list of vulnerabilities,” (they consist of nearly 165% of debt-to-disposable income).
“Given household debt levels,” Wilkins said, “we think that interest rate increases could have a larger impact than in the past.”
Nevertheless, monetary stimulus should continue, she said.
“Monetary stimulus is important to the sustained recovery of demand and can potentially contribute to building supply by supporting investment in capital and increased labor force participation,” Wilkins said. The BOC has for several quarters posited that Canadian growth depends critically on growth in exports and in business investing, leading in both cases to reducing unemployment and increasing consumer spending.
Potential output growth in Canada as in other industrialized economies is going to be lower than in pre-crisis years, averaging just over 2% over the next two years, Wilkins said. That would be one percentage point below average potential growth in the decade before the crisis, she said.
The Bank of Canada defines the neutral rate of interest as “the real risk-free rate of interest that enables the economy to operate at full capacity with stable inflation, after cyclical forces have dissipated,” Wilkins said.