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Mark Carney, the head of the Bank of Canada addresses the annual convention of the Canadian Auto Workers Union in Toronto on August 22, 2012Peter Power/The Globe and Mail

Corporate Canada is justifiably upset by Bank of Canada Governor Mark Carney's criticism of corporate cash levels. Mr. Carney's remarks are unfortunate as they misdiagnose a situation that was created by his own actions.

The decisions any of us make, whether it be an individual or corporation, are based on opportunity costs, defined as the benefits you could have received by taking an alternative action. The opportunity cost of a corporation holding cash is the nominal returns they would receive from investing that cash. These nominal returns can be broken into two components: inflation and real returns.

The opportunity cost of both of these components has fallen. The current rate of inflation is lower than is typical in Canada, thanks to excessively tight monetary policy. Real returns are also quite low by historical standards for corporations in most industries.  What rationale is there to invest in equipment that will increase output if overall market demand is low?

One of the first lessons in Economics 101 is the Law of Demand, which states that, all else being equal, if the price of something falls, the quantity demanded of it will go up. That perfectly describes corporate cash balances, as the price of holding cash has fallen, so companies are holding more of it. Mr. Carney's railing against downward sloping demand curves is about as useful as damning the sun for coming up in the east instead of the west.

Instead of suggesting that corporations violate basic laws of economics, Mr. Carney should instead view high corporate cash balances as a direct effect of his actions, along with the actions of his colleagues at the European Central Bank and the U.S. Federal Reserve.

Mike Moffatt is an Assistant Professor in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business – Western University