The arcane world of central banking has long relied on a couple of standard metaphors to explain monetary policy to the masses. Up until the last recession, central bankers either "tapped on the brakes" or "took away the punchbowl," depending on how irrationally exuberant borrowers and lenders got about the economy.
With the recession, however, central banks in most of the developed world switched from being party-poopers to party organizers. And in words and deeds, Bank of Canada Governor Stephen Poloz has kept the punchbowl filled to the brim since taking over from Mark Carney in 2013.
Mr. Poloz's sudden move Wednesday to cut interest rates will only enhance his reputation as a monetary dove, erring on the side of stimulating the economy now at the risk of generating nasty consequences down the road. He likened the bank's decision to an insurance policy against the negative impact of weak oil prices on Canada's economy. But he made an unconvincing case for taking such dramatic and unexpected action.
To be sure, Mr. Poloz finds himself in good company. Central bankers the world over have driven interest rates to rock-bottom in an attempt to spur growth – or in Europe's case, to prevent the continent from being sucked into a deflationary spiral.
In most cases, deflation is deadly because it leads consumers to put off making purchases now in the belief that prices will go lower in the future. Deflationary traps are extremely difficult to exit, so preventive action must be decisive.
But Canada is not Europe. Falling oil prices may temporarily send inflation below the Bank of Canada's target rate of 2 per cent annually. But as CIBC economist Avery Shenfeld noted in a report last week, "you don't put off fuelling your car because gasoline will be cheaper a month from now. Instead, you buy the gas, save money relative to where things stood last month, and have more left over to shop elsewhere."
Indeed, cheaper oil will provide an unambiguous boost to Central Canada's economy. That Mr. Poloz seems so worried about lower crude prices is reflective of just how much Canada has relied on investment and job growth in Alberta to fuel Canada's economy in recent years.
Even so, Canada's main trading partner – the United States – is rapidly gaining momentum. The Canadian dollar is way down, stimulating both exports and inflation. Even now, the Bank of Canada is projecting 2.1 per cent growth here this year and better times next year. So why hit the panic button?
Mr. Poloz insists he's being transparent about his reasons for cutting rates and he should be taken at his word. But his action fits into a broader postrecession narrative of central bankers endlessly greasing the economy's wheels, fearful of what might happen if they let economic kinks work themselves out on their own.
The result is that yields on European government bonds have fallen to their lowest level since the 14th century, when bubonic plague swept the continent, sowing death and deflation. Europe now faces newer, more persistent plagues – massive debts and mournful demographics – and so the European Central Bank is stirring up yet more punch.
On Thursday, the ECB is expected to announce that it will begin buying government bonds – in effect, printing money. This will enable euro-zone governments to continue borrowing at risible rates and running up big deficits, sending investors into stocks and real estate in search of higher returns.
It's not so different on this side of the pond – see Ontario's deficit and Toronto's real-estate prices.
Critics argue that today's dovish monetary policy has created asset bubbles – in the form of inflated stock and property prices – that will inevitably pop. They fear central bankers are using loose monetary policy to weaken their currencies instead of forcing governments to make their economies more competitive. Anything to get (or in Canada's case, keep) the party going.
"We are in a world that is dangerously unanchored," former Bank for International Settlements chief economist (and former Bank of Canada deputy governor) William White told London's Telegraph newspaper this week. "We're seeing true currency wars and everybody is doing it, and I have no idea where this is going to end."
Central bankers are still pretending it never has to.