Carney and the Bank
Many economists across Canada are breathlessly awaiting Mark Carney’s decision tomorrow regarding interest rates. The Governor of the Bank of Canada may announce that he is starting the long anticipated upward march of interest rates in Canada. Or he may defer this decision because of the uncertainty created by the economic turmoil in the EU. My view is that whatever decision he makes, the anticipation and expected reactions to his decisions are really “much ado about nothing”.
The Bank will start increasing interest rates some time this year. Mark Carney could increase the overnight lending rate from its current 0.25% to 2.50% without having much of an impact on the Canadian economy, including the rate of inflation. Mortgage rates would rise and dampen the housing market somewhat. Otherwise, the future course for the Canadian economy will be driven largely by what happens in the U.S., the EU, China and the commodity markets.
On the other hand, the U.S. Federal Reserve and the European Central Bank need to keep rates low. Not so much to stimulate their economies, but rather to enable their banks to become profitable by taking advantage of the yield curve. Banks, especially in the EU, are still in a precarious situation, unlike the major Canadian banks that have built up their capital base and profits.
There is no need in Canada, the EU or the U.S. to increase interest rates to curb inflationary pressures. The Organization for Economic Cooperation and Development (OECD) has suggested to Mark Carney that he begins to increase interest rates now. Indeed, the OECD is recommending that policy makers in all of the OECD countries should stop promoting economic recovery and begin raising interest rates and slashing spending. The OECD once more is demonstrating its inability to forecast and offer practical policy advice.
But the OECD is not alone. More and more economists are becoming fearful of inflation and are advocating similar policies.
However, there is no inflation problem on the horizon, except for China and possibly India. Deflation is a greater risk at this time for the EU and to a lesser extent the United States. A fragile recovery and high unemployment rates are more serious threats.
Paul Krugman commented in his May 30 New York Times blog: “But what I currently find most ominous is the spread of a destructive idea: the view that now, less than a year into a weak recovery from the worst slump since World War II, is the time for policy makers to stop helping the jobless and start inflicting pain.”
He is absolutely right.
In Europe, some economists and a few policy makers as well are beginning to worry that a danger of deflation, similar to the one that strangled Japanese growth for most of the 1990s, is a bigger threat than inflation. They too are right.
If Carney announces that he is increasing rates because of a future inflation risk, then he needs to go back to the drawing board and take a close look at what is happening around the world and how these events have driven the inflation rate in Canada for the past 20 years. On the other hand, if he increases rates because there is no longer an obvious need for historic low rates, and acknowledges that this will have little impact on the Canadian economy, then he will show that he does understand economics and the global reality.
The opinions expressed in this blog are personal and do not reflect the view of either Global Brief or the Glendon School of Public and International Affairs.