C.D. Howe Institute’s Monetary Policy Council Calls for Bank of Canada to Lower its Benchmark Interest Rate Target to 1.00 Percent

Toronto, January 15 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada lower its target for the overnight interest rate by 50 basis points to 1.00 percent at its next announcement on January 20, 2009. The overnight rate is a very short-term money-market rate that the central bank targets for monetary policy purposes.

The MPC is a panel sponsored by the C.D. Howe Institute to provide an independent assessment of the monetary stance most appropriate for the Bank of Canada as it seeks to achieve its 2 percent inflation target. William Robson, the Institute’s President and CEO, chairs the Council.

The MPC’s formal recommendation is its median vote. While six of the 10 members attending the meeting recommended cutting the rate to 1.00 percent, differing views on the economy, on Canadians’ expectations for growth and inflation, and how aggressively monetary policy should respond to credit-market stresses created considerable disagreement – both about the upcoming setting, and about the appropriate stance of monetary policy over the next year. One member recommended cutting the overnight rate to 0.50 percent on January 20th, one recommended a cut to 0.25 percent, and two recommended holding the rate to 1.50 percent. Looking ahead to the Bank’s interest-rate announcement in March, and then the rate desirable in 6-12 months’ time, the median call remained at 1.00 percent. However, four members wanted a rate of 0.50 percent or below in March, while four members looked for a rate of 1.50 percent in 6-12 months’ time.

The median call for a 50 basis-point cut in the overnight rate target was prompted mainly by recent indicators that weakness in the Canadian economy has spread from the trade sector to household spending and the labour market, and that businesses’ assessments of the growth outlook have turned sharply negative. Council members urging a cut of 50 basis points or more tended also to stress price-level declines, and widespread expectations that inflation will come in below – potentially well below – the Bank’s target. Several in that group felt that the risks of aggressive easing were considerably less than the risks of doing too little, since curbing inflation in the event that policy turned out to be too loose would be easier than remedying deflation if policy turned out to be too tight.

Members who urged an unchanged overnight rate at the upcoming setting, and/or thought the rate should return to its current level over the next 12 months, tended to feel that the disinflationary output gap was less large than slumping demand would indicate, that growth – perhaps assisted by fiscal policy – would resume in 2009.

MPC members were unanimous in feeling that the Bank of Canada’s references to its goal of achieving 2 percent inflation should be especially emphatic in its upcoming statements. Several thought that the Bank should make clear that it was prepared to respond flexibly, with both traditional and less conventional monetary-policy tools, to bring the year-over-year inflation rate back to target as it slips lower in the coming months.

On the question of whether the Bank of Canada should supplement its overnight-rate setting with other tools to ease continued stress in credit markets, the group was not unanimous. Several members urged the Bank to use the overnight rate aggressively, turning to other tools only should it find that interest-rate easing was not sufficiently effective. Others thought there was more scope for the Bank to encourage the replacement of lower-quality assets with higher-quality assets on the balance sheets of financial institutions, and for the Bank – or perhaps the federal government – to more actively support the commercial-paper market.

The recommendation of the MPC is the median of the votes cast by individual members attending the session. The table shows the median votes and individual recommendations for the overnight rate at the January 20, 2009 setting and the March 3, 2009 setting, as well as the group’s views about the target in 6-to-12 months’ time.

The views and opinions expressed by the Council’s members are their own and do not necessarily reflect the views of the organizations with which they are affiliated, or those of the C.D. Howe Institute.

The MPC’s next vote will take place on February 26, 2009, prior to the Bank of Canada’s interest rate announcement on March 3, 2009.

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Contact: Kristine Gray — phone: 416-865-1904; e-mail: kgray@cdhowe.org.