The most recent interest rate announcements from the U.S. Federal Reserve, the European Central Bank and the Bank of England all featured new information about how these central banks would respond to possible future developments. Last week, in its first communiqué under new Governor Stephen Poloz, the Bank of Canada also added words about the path we should expect its overnight-rate target to follow as the Canadian economy returns to more normal conditions.
These statements got lots of attention. Each central bank was trying to fill a gap between the very low interest rates most people expect for quite a while and the higher rates appropriate to the more robust economic growth everyone hopes eventually to see. So far so good – but a better way to fill that information gap would be by publishing the expected policy interest rate path, complete with actual numbers and dates.
These policy interest-rate announcements are key statements of central bankers’ thinking about the outlook for the economy and inflation. Since the 2008 crisis, there hasn’t been much doubt, for most central banks most of the time, about an individual rate setting – they have been holding interest rates stable and very low to keep economies struggling with damaged banks and weak private sector confidence afloat. The news in the announcements has been much more about how central banks describe their future actions, and what might lead them to change rates.
Adding yet more detail to these latest versions made sense. As time passes, the problems created by apparently endless cheap borrowing are worsening. In Canada, as elsewhere, households and governments are going into the red to finance housing and consumption – boosting short-term spending, but drawing resources away from investment and hurting the prospects for long-term growth. The Bank of Canada has been warning, albeit in its typically measured phraseology, that when interest rates do rise to more normal levels, those households and governments will get a nasty shock. But as the C.D. Howe Institute’s monetary policy council has noted several times, the Bank of Canada’s approach has problems.
One is that the bank starts sounding like the boy who cried wolf. The longer it warns that rates must rise without actually raising them or even saying when, the likelier many Canadians are to ignore it. Among closer observers of monetary policy, repeated warnings about higher interest rates raise fears that the bank is tying its hands. It’s clear that faster growth and higher inflation will push the policy rate up sooner and further. But what if growth and inflation fall – does the commitment to a higher rate over time mean the bank wouldn’t drop it in response?
While the added detail in the most recent statements does give a bit more forward guidance about policy interest rates, the crying-wolf and tying-of-hands problems remain. To progress further, the Bank of Canada and others should follow the lead of counterparts – the central banks of New Zealand, Sweden and Norway – that publish the path they expect their policy interest rates to follow: actual numbers on actual dates.
Such a step looks dangerous to the central banks that have not yet taken it. Wouldn’t such explicit statements tie central bankers’ hands more tightly? And wouldn’t a delay in an explicitly mapped rate worsen skepticism that a wolf exists?
Probably not. Smart central-bank watchers understand that all forward guidance is subject to change in the face of new information about the economy and inflation. Central banks can underline this point by publishing, as those of Sweden and Norway do, a chart showing bands of uncertainty around the rate. And any concern that revising an explicit forecast would undermine confidence in central bank competence would likely vanish with experience. We know the Bank of Canada can’t see the future. But we do know its monetary policy matters, and we do want as much information as we can get about how it sees the future unfolding.
The extra words in recent statements are helpful, but still inadequate. The gap is too big between actual low interest rates now and vague statements about higher rates in the future. Publishing an explicit path for the overnight interest rate would fill it. It’s time for the Bank of Canada to give us the numbers.
William Robson is president and CEO of the C.D. Howe Institute.