OTTAWA — When it comes to monetary policy, there appear to be few limits to innovation, both during and after the global economic and financial meltdown between 2007-09.
“Confident as we are in how we do things,” says Canada’s No. 2 monetary policymaker, the Bank of Canada is examining how other countries reacted to that crisis while it “keeps its eyes on the future.”
“One important challenge for central banks now is that conventional monetary policy is stretched to its limits in some countries, where policy interest rates are at, or below, zero,” Carol Wilkins, the central bank’s senior deputy governor, said Friday.
“Because of this, a number of countries are using innovative monetary policy measures to return inflation to target,” she said in a speech to the Rotman School of Management and the Munk School of Global Affairs in Toronto.
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“Canada was fortunate to avoid the worst of the (2007-09) crisis, thanks to the relative strength of our economy, our prudently managed and resilient financial system, and well-anchored inflation expectations.”
But now, given concerns over renewed global economic weakness, “it’s not surprising that we are focusing our research firepower on the monetary lessons from the (previous) crisis,” Wilkins said.
Innovation is a recurring theme among monetary policymakers — even more so than before, due to recent global economic growth concerns that are presenting some new challenges that could require new solutions.
For the Bank of Canada, much of its focus has been on inflation targeting and, since 1991, that has been the prime policy concern when steering overnight borrowing costs for financial institutions through adjustments to the central bank’s key lending rate — now at 0.5 per cent.
Its main policy goal is to guide price movements toward the central bank’s target — currently at two per cent, the midway point of its comfort zone between one and three per cent. The policy is reviewed every five years by the bank and the Finance Ministry, with the process to begin again in 2016.
Ahead of that decision, central bank researchers — along with academics — are “assessing how effective other innovative monetary policy measures have been.” Some initial staff research findings were released Friday.
“These days, most central bankers see inflation targeting as a success,” Wilkins said in her speech.
“The current inflation-targeting framework is working well, so the bar for change is high. But history tells us we can’t cling indefinitely to a particular way of doing business,” she said.
“I wish I could say that was the end of the story. In reality, this success probably distracted central banks from confronting the hard questions about the build-up in financial risks that led to the global crisis. It’s a stern reminder that we must resist confirmation bias and complacency.”
Wilkins said innovation has driven monetary policy, such as the Banks of Canada’s use of so-called “forward guidance” — in which the direction of rates and policy actions is clearly indicated — during the worst on the country’s 2008-09 recession. But Canada managed to avoid other more aggressive actions taken by some countries — such as purchasing corporate bonds and mortgage-backed securities to help ensure financial market stability.
The challenge now, Wilkins noted, is to ensure monetary policies keep pace with “technological and social trends, as well as post-crisis regulatory reforms.”
“When the world is moving around you, standing still is a risky strategy,” she said. “Our commitment to innovation extends to all parts of our business. It will give us the tools to support Canada’s economic and financial well-being.”
History has shown us there are a number of ways to tackle monetary issues. Only a few years ago, many policymakers believed taking their target-lending rate to zero would limit their options. The U.S. Federal Reserve, for one, has been at a near-zero level since 2008, and many European countries have flirted with this limit.
“Many believed zero was where monetary policy was out of bullets. We now observe that some European countries have tested this limit. There, central banks are charging commercial banks for their deposits, and governments are effectively getting paid to borrow,” Wilkins said.
“It’s too early to tell how effective negative rates are at creating additional demand. However, it seems that, in the experience of these countries, the exchange rate channel might be particularly important.”
The Bank of Canada’s key rate has been twice cut by a quarter per cent since the start of 2015 as the global economy was hit by another crisis — this time, the plunge in oil prices — and Canada fell back into recession during the first half of this year, although it is showing signs of overall moderate growth in the second half.