Jeremy Kronick is a senior policy analyst at the C.D. Howe Institute.
Bank of Canada Governor Stephen Poloz announced Wednesday that the central bank was leaving its overnight interest rate at 0.5 per cent with inflation remaining in the lower end of their 1-to-3-per-cent range. Many had been expecting this announcement and, as such, market reaction has been muted. However, two things stand out.
First, the interest rate decision came with an accompanying cut to the bank's forecast for Canadian economic growth due to underwhelming exports, a slowdown in business investment and the uncertainty arising from Britain's decision to leave the European Union.
Second, of late we have seen sterner warnings from the bank reiterating the dangers of the overheated Toronto and Vancouver housing markets and unsustainable levels of household debt.
The difficulty for Mr. Poloz is that these two realities are often at loggerheads when it comes to monetary policy decisions.
The Bank of Canada first and foremost targets low, stable and predictable inflation over the medium term – the idea being that this type of predictable environment encourages productive spending and investment decisions on the part of both Canadians and foreigners. In turn, this contributes to higher standards of living than would be the case under a less predictable regime.
Indeed, research shows that central banks that target inflation do significantly better at creating such a predictable environment than those that do not.
On that score, given both the most recent and previous few years' worth of inflation data, the bank is achieving its primary objective.
But the bank considers other things as well. Specifically, the need "to conduct monetary policy in a way that promotes the economic and financial well-being of Canadians." That gets us back to the two standout issues.
On the one hand, with the bank cutting economic growth forecasts, it's saying that the Canadian economy is weaker than expected and the gap between actual and potential output will take longer to close.
In this type of environment, monetary policy theory would suggest that a lowering of interest rates would be in order. Furthermore, given the weak trade figures, a lowering of interest rates would likely result in a further depreciation of the Canadian dollar, leading to increased exports – a positive result for the economy.
On the other hand, with frothy housing markets in Toronto and Vancouver, and debt levels rising to historic highs, there is fear that more accommodative monetary policy will only exacerbate the situation.
The reverse is also true.
Many have called for a normalization (increase) of interest rates in order to tame borrowing. However, while that may slow down the Toronto and Vancouver markets, it would put a significant dent in every other non-booming housing market in Canada.
Additionally, an increase in rates could choke off other forms of spending, leading to a further slowdown of an economy that has been limping along for a while now – the exact opposite of the result being sought for the overall economy.
If, as appears to be the case, inflation in this country is relatively well-anchored around the 2-per-cent target we have had for a quarter of a century, there should be some flexibility to move interest rates without sacrificing the bank's primary objective.
The problem is deciding which way to go.
In some ways, this is the corner we have all painted central bankers into since the Great Recession.
With governments the world over unable or unwilling to take action on the fiscal side of the equation – in whichever direction your political will leans – central bankers have been left to take up the reins.
Some will argue that they have done too much, or that what they have done has not worked, but the inevitable truth is that they've often been going at it mostly alone.
In the Bank of Canada's case, given that the government has accepted larger fiscal deficits, the bank believes it's prudent to see the impact of this fiscal stimulus on the economy before making any further cuts to the overnight rate.
Furthermore, regulation has been put in place to try and slow down the housing markets in a more targeted fashion and more appears on its way.
For Mr. Poloz and his team, the hope is that these measures allow him to worry less about an unsolvable equation and focus more on being a good old-fashioned inflation targeter.