Friday, 13 November 2015 18:52
TORONTO: The newly found ability for central banks to have negative policy interest rates lessens the need to raise the inflation target, the Bank of Canada concluded in a discussion paper published on Friday.
The article was released simultaneously with a speech by the bank’s senior deputy governor, Carolyn Wilkins, in which she reiterated the stance that the current inflation-targeting framework is working well “so the bar for change is high.”
Next year the central bank and the federal government have to renew the bank’s five-year inflation-targeting mandate, which currently tries to keep inflation at 2 percent.
Wilkins noted that with reduced growth potential now, the neutral rate of interest is lower than before the global crisis, meaning it is more likely policy interest rates will fall to zero than in the past if the inflation target is kept at 2 percent, limiting the margin for conventional monetary policy.
But the Bank of Canada research paper, to which she referred in her speech, found that negative policy interest rates restore some room to maneuver.
“To the extent that policy interest rates can be reduced meaningfully below zero temporarily with limited costs to financial stability, arguments that the inflation target should be raised in response to a lower neutral interest rate become less powerful, particularly given the costs that permanently higher inflation poses on society,” the paper said.
However, analysis was needed on whether negative policy interest rates are a viable tool over an extended period of time, and also on how low rates can go, it said.
It therefore remains an open question as to whether the ability to have negative policy interest rates, effectively charging banks for their deposits, can sufficiently compensate for the decline in the neutral interest rate, it added.
In the text of the speech Wilkins was giving in Toronto, she highlighted a number of areas of research, including alternative futures dominated by e-money like Bitcoin.
“This would create a new dynamic in the global monetary order, one in which central banks would struggle to implement monetary policy,” she said.
The bank also released research which found that forward guidance can be an effective tool, when policy rates cannot be cut further, but the benefits need to be weighed against the costs of potential loss of credibility and increased financial stability risks.
Another research paper found central bank asset purchases, or quantitative easing, were successful in lowering yields.
