Interest rate shouldn’t be seen as main tool to shore up financial stability: Bank of Canada

OTTAWA – Rates of interest shouldn’t be the only real tool to promote financial stability, said the financial institution of Canada’s Timothy Lane, amid worries of highly indebted consumers and frothy housing markets in Toronto and Vancouver.

Lane, deputy governor from the Bank of Canada, designed a speech in Montreal Monday concentrating on monetary policy’s effects on financial stability. The financial institution of Canada has been loosening policy in the past year as Canada handles an adverse terms-of-trade shock because of the collapse in oil prices.

Lane asserted when the Bank of Canada had not cut rates of interest last year – by 25 basis points in January and by another 25 basis points in July, bringing the overnight lending rate to its current 0.5 percent – it could have worsened the Canadian economy and caused a crisis. Avoiding that outweighed creating a further imbalance in household debt and some housing markets in Canada, he explained.

Instead, Lane asserted those imbalances could be offset with further aid from fiscal policy.

“In a situation of sustained weak aggregate demand, relying mainly on monetary policy to supply stimulus may lead to financial vulnerabilities that macroprudential policy cannot, or should not, offset,” he explained. “In such circumstances, fiscal policy might be called upon to provide stimulus, particularly as it is apt to be more efficient at low interest.”

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Lane said that government spending, together with macroprudential tools, can both be used to help aid financial stability in Canada. He pointed towards the use of regulatory measures such as the rise in the minimum deposit for mortgage amounts above $500,000, entering effect this month, as you method to temper risks.



But government spending, too, can make its own imbalances. Canada saw its debt balloon in the 1980s and 1990s, which led to a debt downgrade from the ratings agencies in 1992. It took six years to balance the budget and restore Canada’s AAA rating.

Lane referenced the ’90s to illustrate the risks of relying too heavily on government stimulus. Instead, he suggested that both monetary policy and fiscal policy need to operate in concert with one another to avoid imbalances in the public and private sectors.



“These issues are relevant to the renewed discussion of fiscal policy that’s now happening in Canada,” he said.

Lane’s speech, however, offered no hints about what the financial institution of Canada is going to do at its next policy meeting, looking for March 9. His speech is one of only two before the announcement, with deputy governor Lawrence Schembri scheduled to talk later this month.

At its Jan. 20 meeting, the central bank opted to hold its overnight lending rate at 0.5 per cent, saying that there have been signs that the low loonie was leading to an export recovery in the non-energy segment from the economy. At that time, bank governor Stephen Poloz also asserted the bank delays to determine the facts of the federal government’s fiscal spending announcement.

Financial Post

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