For the second year in a row the OECD has called on the Bank of Canada to raise interest rates. For the second year in a row, the OECD has made the wrong call.
In its May 2012 Economic Outlook, the OECD projects both the CPI and core CPI measures of inflation in Canada to be between 2.0-2.3 per cent, hardly the hallmark of an overheating economy. Unemployment this year is projected to fall to 6.9 per cent in 2012 and 6.6 per cent in 2013, figures above the levels seen in 2007 and 2008, before the recession began in earnest. The report indicates that the situation in Europe is still unstable and the Euro area could plunge into recession at the end of the year.
Monetary policy through changes in interest rates is analogous to walking a tightrope – one needs to be careful not to fall to either side. Given that there exists significant downside risks to the Canadian economy thanks to a weak global economy, but the risk of the Canadian economy overheating in the short term is small, the prudent course of action would be to stay the course on interest rates until at least 2013.
The OECD does bring up legitimate concerns about high and rising house prices, particularly in Vancouver and Toronto. Altering interest rate policy to ensure mortgage borrowers do not get in over their heads is a very blunt instrument given that they affect the money supply as well as business lending. Reforming CMHC and refusing to increase its $600-billion mortgage insurance cap would be a good start. Changing criteria for HELOCs (home equity lines of credit) and cash-back mortgages should also be considered though are not popular with everyone.
Using interest rate policy to deflate a housing bubble is like using a shotgun to kill a housefly: ineffective and likely to cause a lot of collateral damage. Given the current rates of inflation and unemployment, there appears to be no reason to raise interest rates until 2013 at the earliest.
Mike Moffatt is an Assistant Professor in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business - Western University. Mike also does private sector consulting for the chemical industry and can be found on Twitter at https://twitter.com/#!/MikePMoffatt.