A committee of economists that closely follows the Bank of Canada is deeply divided on where the Canadian economy is headed over the next year, providing a window into the difficulty Mark Carney faces in charting a course back to a more normal interest rate setting.
The club in question is the Toronto-based C.D. Howe Institute’s Monetary Policy Council, which publishes an interest rate recommendation a week ahead of the Bank of Canada’s official announcements.
Mr. Carney, the Bank of Canada Governor, will update his policy stance Wednesday after a week of deliberations with his deputies on the Governing Council and central bank staff.
With economic conditions as unsettled now as they were at the time of the Bank of Canada’s last policy announcement on July 17, there is little reason to expect a shift this week. Mr. Carney will surely leave the benchmark rate at 1 per cent, where it has been since September 2010. He will also likely continue to signal that he is anxious to raise the overnight target as soon as threats such as the European debt crisis dissipate.
C.D. Howe’s shadow committee debates what they think policy should be, not what they think the Bank of Canada will do. All but one say the benchmark should be left alone. (Nicholas Rowe of Carleton University would cut it to 0.75 per cent.)
But when it comes to a year from now, the consensus evaporates. That matters because the Bank of Canada’s decisions have as much to do with future conditions as present ones. If the outlook is as cloudy as the divisions on the C.D. Howe committee suggests, there is a greater chance the Bank of Canada will make a mistake as it moves the benchmark rate back to a more normal setting around 3 per cent.
Four members think that one year from now, the overnight rate will be 1.5 per cent. Prof. Rowe and Pierre Siklos of Wilfrid Laurier University and the Centre for International Governance Innovation suggest it will be 0.75 per cent; Stéfane Marion and Avery Shenfeld, the chief economists at National Bank Financial and CIBC World Markets, respectively, recommend 1 per cent. The other four recommendations range from 0.5 per cent to 2.25 per cent.
Such a dramatic splintering of views is unusual. It highlights the confounding nature of an economic recovery from a global recession in 2009 that is unusually halting.
Adding to the consternation is growing unease about the longer-term effects of leaving interest rates so low for so long.
William White, the Canadian economist who correctly said former Federal Reserve chairman Alan Greenspan’s low-interest-rate policy fuelled a housing bubble, said in a research paper last week that the time has come for central banks to reverse ultra-low borrowing costs or risk a new financial crisis.
“The [Bank of Canada] has been too timid moving rates up when it could have done so easily in the first half of 2011,” when the economy was stronger, said Thorsten Koeppl, an associate professor of economics at Queen’s University and the C.D. Howe committee member who thinks the benchmark rate should be 2.25 per cent a year from now.
Prof. Koeppl is sympathetic to Mr. White’s thesis that monetary policy has pretty much run its course. In an e-mail from Switzerland, he noted that a benchmark rate above 2 per cent still would be low by historical standards. He added that he is worried summer droughts and the recent surge in oil prices will put upward pressure on inflation.
If that is the case, the Bank of Canada will have to lift the benchmark rate sooner rather than later to keep price increases at its 2 per cent target. Prof. Koeppl would leave the benchmark unchanged this week and again in October, but push the rate to 1.5 per cent by March.
Others on the shadow committee doubt the economy will be strong enough to handle such an increase.
Ted Carmichael, a managing director at the Ontario Municipal Employees Retirement System, imagines dropping the overnight target to 0.5 per cent early next year and leaving it there at least through September. (He says his views on monetary policy are his own and not those of OMERS.)
Mr. Carmichael foresees a global economic slowdown as many European countries struggle to escape recession and growth slows in big emerging markets such as China and Brazil.
Almost every other major central bank already is cutting interest rates, and should be expected to do so as the global economy continues to slow, Mr. Carmichael said. Under those circumstances, the Bank of Canada would be forced to follow or risk inflating the value of the currency. “We still have some ammo left here, some dry powder that others don’t have,” Mr. Carmichael said from Toronto.
Mr. Carney will not use his “ammo” this week. Whether he will do so a few months from now has rarely been so difficult to predict.