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The Bank of Canada in Ottawa.Adrian Wyld/The Globe and Mail

The Bank of Canada is exploring the idea of working more closely with Ottawa to co-ordinate interest-rate relief and government spending during economic slumps – a path some economists say could endanger the bank's independence.

Emerging risks – including slow growth and historically low interest rates in the financial market – could make monetary policy less effective when the next shock hits, deputy governor Lawrence Schembri warned in a speech on Thursday to the Manitoba Association for Business Economists.

Among the options to strengthen the bank's monetary policy framework is "more explicit" co-ordination of policy moves with government spending programs, he said.

"The experience during the [2008-09 financial] crisis, when both aggressive monetary and fiscal stimulus were used, highlighted the benefits of simultaneous policy action," Mr. Schembri pointed out.

The proposal comes as the central bank lays the groundwork for the next scheduled five-year renewal of its 2-per-cent inflation target in 2021.

Higher levels of household and government debt, a long-term decline in interest rates in the broader economy and slow growth are all making the job of central banks more difficult, Mr. Schembri said. Real – or after-inflation – interest rates have slumped to near zero from more than 6 per cent in the early 1990s, limiting the influence of monetary policy.

"Countercyclical fiscal policies, such as automatic stabilizers, and discretionary policies, such as infrastructure spending, are highly effective," Mr. Schembri said. (Government stabilizers are programs such as employment insurance that automatically prop up the economy when slumps lead to higher joblessness.)

Mr. Schembri acknowledged that the prospect of the independent central bank working more closely with the federal government raises "governance issues" for both Ottawa and the bank.

Conference Board of Canada chief economist Craig Alexander called the idea dangerous.

"The central bank cannot afford to lose its independence," Mr. Alexander warned. "No one would want politicians deciding where interest rates should be set because there could be conflicts between political and economic goals."

A more workable alternative would be an arrangement that automatically boosts jobless benefits when the economy stalls, he said.

CIBC chief economist Avery Shenfeld expressed qualified support for the proposal.

"It's an interesting idea, and a sound one given the concern that in the next recession, we might run out of room to cut interest rates," Mr. Shenfeld said.

However, he cautioned that future governments could easily counteract their predecessors' co-ordinated action, either by writing legislation to undo it or through offsetting spending moves.

The Bank of Canada has stuck with the 2-per-cent inflation target since 1995 as the centrepiece of its monetary policy framework. The bank reduces its benchmark rate when growth is weak and inflation appears to be falling below the target. On the other hand, when the economy is growing at a healthy clip and inflation is starting to perk up, the bank can raise rates to cool things down.

Among other options is an adjustment in the 2-per-cent target, signalling to markets exactly where its benchmark rate is headed, large-scale purchases of government bonds and other assets such as price-level targeting, Mr. Schembri said.

Mr. Schembri's remarks did not touch on the timing of the next rate move by the Bank of Canada, which has raised its key rate three times since last June, to 1.25 per cent. The bank's next rate-setting announcement is scheduled for March 7.

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