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

Toronto, June 2 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada hold its target for the overnight interest rate at 0.25 percent at its next announcement on June 4, 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. On this occasion, the consensus on the desirable target at the next setting was unanimous, with all seven members attending the meeting advocating a target of 0.25 percent. Looking ahead to the next setting on July 21, all but one member supported maintaining the target at 0.25 percent. When asked to look 6-12 months out, however, the group’s views diverged and individual calls were strongly qualified by the possibility of further economic shocks: while three called for an unchanged target of 0.25 percent, three called for a target of 0.75 percent, and one called for 1.00 percent.

The general tone of the discussion was more positive about the near-term outlook for demand and output than in the run-up to the Bank of Canada’s last interest-rate announcement on April 21. The group noted signs of stabilizing and possibly recovering economic activity in North America and Asia, as well as an improved tone in financial markets. With the threat of deflation having receded in measures of inflation expectations, members were inclined to think that monetary policy’s main task is now to steward a sustainable recovery, rather than avert a disaster.

Uncertainties on several key points preoccupied the group: the calls for the overnight-rate target further were not only dispersed, but strongly qualified.

While the group felt that fiscal and monetary stimulus has not yet gone so far as to provoke serious fears about unsustainability and inflation, several members expressed concern that the United States in particular would have trouble pulling back in time. For Canada, rising government-bond yields and inflation expectations abroad could create exchange-rate and other stresses: the Bank of Canada might need to tighten monetary policy to ensure the credibility of its inflation targets, even while a rising Canadian dollar was reducing measured inflation in Canada.

Additional points of uncertainty were:

The extent to which the Canadian economy’s capacity to produce goods and services might have shifted downward as a result of recent restructuring, and might grow more slowly in the years ahead; 

Whether the narrowing of spreads, both short- and long-term, between yields on government- and private-sector securities is a desirable return to a sustainable level, or whether rising yields on government securities reflect an undesirable increase in sovereign risk and inflation expectations;

How closely the Bank should monitor or guide measures such as the monetary base and growth in the money aggregates;

and Whether continued financial-system fragility, particularly in the United States and Europe, might derail the recovery.

As the Bank of Canada navigates these uncertainties, the group urged it to emphasize strongly and consistently the primacy of its 2-percent inflation target. With commentary in the financial media and elsewhere focusing on central-bank efforts to shore up the financial system and support economic expansion, the Council felt that the Bank needed to reinforce its message, with the aim of stabilizing Canadians’ expectations about inflation at 2 percent.

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 June 4, 2009 setting and the July 21, 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 July 16, 2009, prior to the Bank of Canada’s interest rate announcement on July 21, 2009.

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