July 13, 2011 – The time is right for the Bank of Canada to start raising interest rates, according to a report from the C.D. Howe Institute. In “Overnight Moves: The Bank of Canada Should Start to Raise Interest Rates Now,” leading monetary economist Michael Parkin warns that delayed action poses risks and the prospect of “ugly policy choices” ahead.
“If more ‘no-change’ decisions are made by the Bank of Canada regarding its policy interest rate, inflation expectations might begin to slip loose of their 2 percent anchor,” says Parkin, an Emeritus Professor of Economics at the University of Western Ontario. Further, with the Fed continuing to hold a near zero rate, the US dollar is likely to continue its slide. If the Canadian dollar moves with the greenback, because the Bank of Canada keeps its interest rate close to the US federal funds rate, the high inflation rates of energy and other commodity prices, which currently are seen as temporary, might start to look permanent, says Parkin.
Alongside these concerns is monetary policy’s limited effect on economic growth, the output gap, and the unemployment rate. The best contribution that monetary policy can make in pursuit of these objectives is a low and predictable inflation rate. Vigorous pursuit of output and employment objectives might end up spilling over into inflation, as the real economy remains stubbornly unresponsive, says the author.
The forgoing concerns are statements about risks, not central forecasts, Parkin says. But they are outcomes that, if they occur, bring an ugly set of policy choices. A return to seriously above-target inflation can be addressed only with seriously above-normal interest rates. That is a risk worth avoiding. And it can be avoided only by embarking sooner, rather than later, on the process of steadily increasing the overnight rate target.
The C.D. Howe Institute publishes regular commentaries on monetary policy. This report by Michael Parkin is the first of three forthcoming discussions pertaining to when, and by how much, the Bank of Canada should raise its target overnight interest rate. They include the recommendation of the Institute’s Monetary Policy Council on July 14 for the Bank of Canada’s July 19 interest-rate setting.
Click here for the full report.
For more information, contact:
Michael Parkin, Emeritus Professor, University of Western Ontario,
Research Fellow, C.D. Howe Institute;
Benjamin Dachis, Policy Analyst,
C.D. Howe Institute; 416-865-1904; Email: cdhowe@cdhowe.org.