Judging by some of the news coverage (including The Globe and Mail's) of Mark Carney's impending early departure from the Bank of Canada, you would think he cured cancer, ended hunger or at least saved a cat from a tree during his time as Governor. True, Mr. Carney was one of a phalanx of central bankers and government officials who worked to save the world's financial system from complete collapse four years ago. But it's far too early to put up the "mission accomplished" banner and call it a day.
At least half the job of restoring the Canadian financial system to health has yet to be done, and in many ways it's the more difficult half. That's the assessment of Don Drummond, a leading Canadian economist and former senior Department of Finance official, and he's right: Central bankers pretty much threw out the playbook to handle the credit crisis, and have created a situation ever since that is having all kinds of other disruptive effects.
Prior to the crisis, there was a firm belief among monetary policy experts that low inflation translated into financial stability. That meant the role of central bankers was simple: keep inflation in check. But in this downturn, "we discovered there's a shock to financial stability that comes from something other than inflation" and that "monetary policy quickly hit the lower bound," said Mr. Drummond in an interview. Now, central bankers "have almost run out of tools to generate a firmer and more durable economic recovery."
The collateral damage from a sustained period of ultra-low interest rates, not to mention the current unprecedented environment, is piling up. Canadians are borrowing record amounts (Mr. Carney and Finance Minister Jim Flaherty have admonished them to hit the brakes, but they are merely reacting rationally to the availability of cheap money). Pension plans are finding it much harder to fund their liabilities through investment (a consequence of low rates bringing down long-term bond yields). And Canadians have lost the incentive to save. Instead, they've borrowed huge amounts of mortgage debt, which has driven housing prices to uncomfortably high levels.
In other words, low rates are having a significant impact on millions of Canadians, and the potential consequences are disturbing. Presumably the price to society should be matched by a benefit – a return to solid economic growth. Instead, the recovery has been weak, and what used to pass for tepid growth – say, a 2-per-cent rise in GDP – might be as good as it gets for a long while (and much better than we're seeing now).
Interest rates can't go much lower, so we are at risk of being stuck in "a gigantic classic Keynesian liquidity trap," Mr. Drummond said. That's about the last thing monetary policy gurus expected after assuming they had learned to manage economic cycles in an orderly fashion through interest rate movements.
The fear now is that it will take central bankers and fiscal policy makers years to figure their way out of this situation (Japan has been stuck in a liquidity trap for a generation). Put the champagne back in the fridge, and instead, order up a strong pot of coffee for Mr. Carney and his successor in Canada; they're going to need it.
Sean Silcoff