Summary
-
The Bank of Canada reiterated last week that it expects to keep its policy rate at 0.25% until next June, “conditional on the outlook for inflation.” Because of the difficulty of gauging excess capacity in the economy, the Bank’s inflation safety margin could be slimmer than it thinks.
-
The current output gap is about the same as in the 1990 recession and inflation is only 1.4 points lower. The real policy rate, however, is almost 8 points lower than it was then. The historical three-way relationship of output gap, real rates and inflation rate no longer seems to hold.
-
A close look at the Bank’s scenario for the economy leads inescapably to the prospect of a highly aggressive tightening campaign from mid-2010 to mid-1011, along with abnormally short time lags for transmission of monetary policy to the economy.
-
From mid-2010, when the Bank says it expects to begin raising rates, to mid-2011, when it expects the economy to be back to capacity production, the Bank would have only 12 months to get its real policy rate up from the basement – close to minus 2% – to an appropriately neutral point.
-
The time for tightening is not yet at hand, but June 2010 seems too late. The day when the condition for the Bank’s low-rate commitment is no longer met will probably come before then.
