C.D. Howe Institute’s Monetary Policy Council Urges Bank of Canada to Raise Overnight Rate to 1.00 Percent, With Increases to 1.50 in March and 2.25 Percent by September 2011

Toronto, September 2 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada raise its target for the overnight interest rate (the very short-term money-market rate the Bank targets for monetary policy purposes) to 1.00 percent at its next announcement on September 8, 2010. The Council recommended maintaining the target rate at 1.00 percent at the following announcement on October 19, 2010, followed by increases that would take it to 1.50 percent in March 2011 and 2.25 percent in September 2011.

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. There was considerable variation in members’ views, even for next week’s setting. Eight of the 11 members attending the meeting recommended a target of 1.00 percent next week, while two recommended 0.75 percent and one recommended 1.25 percent. For the announcement in October, most members called for a target of 1.00 to 1.25 percent, while other recommendations ranged from a low of 0.75 to a high of 1.50. As the time horizon lengthened to a year, a strong division emerged, with six members looking for a target of 1.75 to 2.25 percent, while four called for 3.00 percent and one called for 3.75 percent.

While the generally rising trend in the group’s recommendations over the coming year reflected a view that the Bank of Canada should continue to unwind the emergency measures adopted after the 2008 financial crisis, many members emphasized downside risks to growth that have become more serious since the Bank’s last overnight rate setting in July. These would warrant a slower reduction in monetary stimulus to hit the 2 percent inflation target. Disappointing indicators of demand and output in both Canada and the United States figured prominently in the discussion, with weakness in commodity prices and decelerations in credit and money growth also being mentioned.

Members who favoured more rapid increases in the overnight rate and higher targets in 12 months’ time tended to emphasize Canada’s position among countries less damaged by the crisis, where the financial system and monetary transmission mechanisms have continued to operate, and where returning policy rates to levels consistent with longer-term stability in inflation is more appropriate.

Among the uncertainties affecting monetary policy at this point, the MPC devoted considerable attention to three.

Whether the Canadian economy’s productive capacity relative to current and future patterns of demand has fallen and/or is going to grow more slowly than in the past was a point of discussion, with some members observing that estimates of the disinflationary output gap have tended to shrink over time. Some concluded from this that more rapid increases in the overnight rate are appropriate, but a couple also noted that slower growth in potential output implied a lower level for the policy rate in the long run.

A related point of discussion was the apparent stability of inflation expectations, which may reflect less disinflationary pressure than other indicators would suggest, but may also reflect years of increasing confidence in the 2 percent target – which leads forecasters expecting more economic weakness also to forecast more stimulative monetary policy to offset it – or simply lags in revising published forecasts.

A final point of uncertainty was the future of fiscal stimulus, especially in the United States – and, given its disappointing impact on demand to date – what the consequences of its winding down or continuation would be.

The table shows the median votes and individual recommendations for the overnight rate at the September 8, 2010 setting and the October 19, 2010 setting, as well as the group’s views about the target in 6 and 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 October 14, 2010, prior to the Bank of Canada’s interest rate announcement on October 19, 2010.

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