Two Cheers for the Bank of Canada

Kudos to the Bank of Canada for significantly reducing its target interest rate from 1% to 0.5%.

A month ago, it took the position that already-announced monetary and fiscal stimulus was sufficient to propel a swift economic recovery later this year. Today, in both word and deed, it acknowledged worsening economic conditions and the need for more stimulus.

Why Not Cut Further?

However, the Bank of Canada should have cut its target even further. The economy clearly needs all the stimulus it can get and there is no threat of inflation rising above the 2% target.

Since the Bank targets a 0.5% range, it could have set the bottom of this range at 0% by announcing a target rate of 0.25%. Today’s release acknowledged this possibility: “the target for the overnight rate can be expected to remain at this level or lower.” Although an extra 0.25% reduction would not have been economically decisive, it is unclear why the Bank did not go as far as possible in trying to provide stimulus through lower interest rates.

The central bank deserves two cheers for cutting rates two-thirds as much as it could have.

What’s Next?

In any case, interest-rate policy nearing the end of the road begs the question of what else should be done. The Bank rightly raises the possibility of deploying other monetary-policy tools: “credit and quantitative easing.”

But today’s announcement should also put the spotlight back on fiscal policy. Governments no longer have the excuse that the Bank of Canada will provide whatever additional stimulus is needed by cutting interest rates.

Yesterday’s GDP figures revealed that a $9 billion increase in public spending on goods and services barely prevented an economic contraction between 2007 and 2008. For 2009, the federal government has put forward $18 billion of Budget measures minus $8 billion of austerity from the Economic Statement. The net $10 billion of stimulus is far too small to mitigate the economic problems it is intended to address.

Upcoming provincial budgets will be critically important in providing further fiscal stimulus. However, the federal government should not be let off the hook. Canadians should demand a second federal stimulus package. However, this package must be larger and better targeted than the $3 billion of discretionary funds that the federal government has requested from Parliament.

UPDATE (March 4): Quoted by The Toronto Star