A senior Bank of Canada official says the central bank is looking at how the high levels of household and public debt could pose a challenge to how it manages monetary policy.
In a speech to the Manitoba Association for Business Economists on Thursday, Lawrence Schembri said low interest rates have encouraged households to take on debt and higher levels of government debt are largely a legacy of the financial crisis in 2008-09.
“Now there is less space, on average, across the G7 for more borrowing to stimulate demand,” he said according to notes of his speech released in Ottawa.
The central bank is also looking at what the gradual decline in interest rates over the past 25 years as well as a reduction in the estimates of the “neutral interest rate” mean for the monetary policy framework.
Schembri defines the neutral interest rate as “the interest rate consistent with the economy growing at its potential and inflation staying on target. It serves as a benchmark for us to gauge the degree of monetary stimulus in place and provides a medium- to long-run anchor for the policy rate.”
The Bank of Canada’s current estimate of the neutral rate of interest is 2.5% to 3.5%, down from a range of 3.0% to 4.0% a little more than three years ago.
Schembri said the trend rate of economic growth has been decreasing and that could also pose challenges because cyclical forces that normally help propel an economy out of an unexpected downturn my be less powerful.
During the financial crisis, both aggressive monetary and fiscal stimulus were used to help boost the economy.
Schembri noted that although monetary policy is normally seen as the most effective countercyclical policy tool, it may need help from other policies more frequently in the future.
“Indeed, studies have shown that when rates are at the effective lower bound, countercyclical fiscal policies, such as automatic stabilizers and discretionary policies, such as infrastructure spending, are highly effective,” he said.
“Our agreement with the federal government includes a commitment by both the bank and the government to the inflation target. that means all economic policies — including monetary, fiscal and marcoprudential — can work together in a complementary fashion for this purpose.”
The Bank of Canada sets its key interest rate target with the goal of keeping inflation at 2%.
It has raised its target for the overnight rate three times in the past year after cutting it in response to a drop in oil prices.
The benchmark rate, which influences the prime rates at Canada’s big banks, stands at 1.25%.