Canada is still struggling to recover from the recession.
As such, the Bank of Canada’s been pushed harder than ever to understand what’s holding the economy back, said Deputy Governor Carolyn Wilkins today during a speech in Toronto.
She finds, “The recovery from the global financial crisis has been underwhelming, to say the least. It has left us debating what kind of growth we can reasonably expect after so much disappointment.
“It has also left us debating how central banks should conduct monetary policy without compromising financial stability. During the crisis, central banks and governments took unprecedented action…But even this forceful policy response could not prevent a severe and protracted global recession.”
In fact, says Wilkins, “the loss to global output was roughly $10 trillion by the end of last year [and] the crisis left the global economy with 62 million fewer jobs,” based on data released by the International Labour Organization.
In the last two years, global growth has averaged only around 3%, which she adds is “well below the average prior to the crisis, and it is unlikely that 2014 will be much better.”
So, what does the BoC plan to do to kick-start Canadian growth?
Already, Wilkins says the bank’s working to figure out how much of the country’s slow growth is tied to cyclical factors versus structural problems. This involves looking at: demographics and the labour market; what drives production levels; and the growth potential of domestic companies.
The BoC forecasts “some of the potential lost during the crisis will be restored through higher business investment and firm creation,” says Wilkins. But “opinions vary on this [since some experts theorize] there’s chronically deficient demand in the global economy.
“This isn’t the Bank of Canada’s baseline view,” however, since it “expects the cyclical factors restraining growth to continue to dissipate over the next few years.”
A look at interest rates
Regarding interest rates, says Wilkins, “the gap between the policy rate and the neutral rate serves as a gauge of the degree of monetary stimulus in the economy. It helps us to calibrate monetary policy.
“The neutral rate…is the real risk-free rate of interest that enables the economy to operate at full capacity with stable inflation after cyclical forces have dissipated. It’s the interest rate that generates just enough savings to finance investment in the long run. [And] since savings can flow across borders, the neutral rate in Canada is influenced by both domestic and foreign factors.” For more on the neutral rate, click here.
Currently, she says our neutral interest rate is lower than it’s been historically due to falling rates around the globe, as well as due to the widening credit spreads of Canadian companies and a surge in worldwide savings rates.
Wilkins estimates “the real neutral policy rate is currently in the range of 1% to 2%. This translates into a nominal neutral policy rate of 3% to 4%, down from a range of 4.5% to 5.5% in the period prior to the crisis.”
Still, she notes, “the neutral rate serves as an anchor for our models and analysis, but it’s not a fixed beacon because the structural factors that influence it can change over time.”
Also, “As long as the factors leaning on growth persist, a policy rate below neutral would be required to maintain inflation sustainably at target.”
However, Wilkens doesn’t expect interest rates to dip into negative territory, especially if the majority of economic headwinds are cyclical.
In her conclusion, she points out that “continued monetary stimulus is needed to return the Canadian economy to sustainable growth and to maintain inflation at target.
“And, depending on the evolution of the data, it’s possible that persistent headwinds will mean that some degree of stimulus will be required even after the output gap is closed to keep inflation at target.”
To check out the speech, click here.
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