Canada’s central bank is flooding the credit market, and hoping nothing sinks. The Bank of Canada (BoC) made an unscheduled rate decision today, dropping the policy rate to just 0.25%. The decision is the third cut just this month, and marks a return to the lowest policy rate Canada has ever seen.
Policy Interest Rate (Overnight Target)
Quick overview of why you should care about the policy interest rate or overnight target, and what it means. The target rate influences the interest major banks charge amongst themselves, for overnight lending. The rates are lowered during periods where the central bank needs to encourage borrowing and investing. If rates are too low however, it spurs unnecessary growth and/or inflation. It also penalizes savers and forces them to look elsewhere, or lose money in real value. Too low of rates is just as bad as too high – arguably worse.
Put more bluntly, generally rates rise during good times, and fall in bad times. An increase, while not fun to pay more interest, means the economy is humming at a pace that needs cooling. When rates fall, it is a negative event – which means the economy is in need of stimulus. A minor cut during a moderate time can give a big boost to markets. A big cut could mean central markets are worried about future job losses. Cheap debt has limited use without income.
Canadian Interest Rates Dropped Back To The Lowest Level Ever
The BoC made an unscheduled drop to the overnight target today, and a big one. The rate today is now just 0.25%, down 150 bps from a month before. This is the third 50 bps cut in March, wiping out all increases made under the current administration – and then some. Money amongst banks is now at the same low, only seen during the worst part of the Great Recession.
Bank of Canada Policy Rate
The policy rate set by the Bank of Canada.
Source: Bank of Canada, Better Dwelling.
The triple change is highly unusual. Even the BoC warns “central bankers must be patient while waiting for the results of their policy actions.” The reason is, the impact to the economy doesn’t translate for months to years. The central bank estimates it takes 12 to 18 months to see the change to aggregate output. The impact to inflation is even further out, with an estimate of 18 to 24 months.
What does this mean? Not even the central bank knows how this is going to work out. Typically a recession requires a 400 bps drop to interest rates, to fire up the economy again. The BoC fired almost all of the bullets in the chamber in advance of a recession. They’re now hoping that flooding the market with cheap credit can prevent a recession. One problem is, how much can some of the world’s most highly indebted households borrow at this point?
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Drop is an immediate decline for currency, so they’re hoping it’ll bump exports and incentivize people to make lower waged employment than USD.
It’s very third-world of us.
That’s what you get for appointing an export person to the head of monetary policy. Dumbest idea in a very long time. Good riddance.
The following numbers are from the Bank for International Settlements (BIS) as of the end of the 3rd quarter, 2019:
Total credit to the non-financial sector (core debt), % of GDP
Greece – 294.1
Canada – 303.2
https://stats.bis.org/statx/srs/table/f1.1
The following BIS chart shows Canada’s total credit to its non-financial sector (core debt), as a percentage of its GDP from 1990 to the end of the 3rd quarter of 2019:
(In 2006 it was 213)
https://stats.bis.org/statx/srs/tseries/CRE/Q.CA.C.A.M.770.A?t=f1.1&c=&p=20193&i=6.10
I am baffled by the suggestion that we are not definitely going into recession. From a global standpoint this started in December, in China. Then we had the rail strike that shut Canadian shipping off for 3 weeks? I can’t even remember that monumental shock to our economy because it was immediately overshadowed by a pan-fricken-demic.
The world had stopped working and has no clue as to when it will resume, but we know it won’t be by golf season Donald.
I think it’s safe to say that a recession is underway, if not complete and utter economic collapse.
I cannot shake the feeling that the economic fallout from this is going to be worse for public health than the direct viral impact. Because it feels like the tools that governments are fighting this with, are mismatched to the problem.
Recent economic downturns have been triggered by asset class bubbles that quickly deflate (residential real estate, dot-com startups). The bubble popping had negative effects on financial markets (Mortgage Backed Securities, stocks), which in turn had negative effects on the general economy. In both cases, the effect on the economy was a sudden, sharp drop in demand. To deal with the demand drop, governments engaged in both fiscal stimulus(lowering interest rates, printing money) and monetary stimulus(cash bailouts, buying distressed bonds).
Now we are here in our surreal pandemic landscape. One can argue we were in a debt-fueled ‘everything bubble’ that was inevitably going to pop, and I wouldn’t disagree. And that’s how governments are treating this … but it does not address the problem. The immediate problem is that governments mandated a collapse in revenue/income. Traditional monetary and fiscal ‘stimulus’ is going to do little. 40% of small businesses face insolvency in the next 6 weeks, regardless of the bailout minutiae . 30% of consumers face insolvency in the next few months. There are too many people and small businesses who have been living check-to-check for this not be a near existential problem.
So what are the right tools for dealing with a government mandated shutdown of revenue? It seems obvious to me that it must be accompanied by a government mandated shutdown of expenses. For example, since rent is the biggest cost of many at-risk people and businesses, why not freeze/eliminate all rent, mortgage, lease payments, property tax, utility and interest payments for the next 3 months? Extend bond/lease/rental maturities out 3 months, and pretend as if the current 3-month shutdown months never existed. Just eliminate that flow of money altogether for 3 months. There is no moral hazard here, as these businesses were not shut down by something they could control. The government wouldn’t have to spend or print money to make this happen, so they wouldn’t have to risk national insolvency in order to address the problem. The total dollar amounts would dwarf anything the government could possible offer in cash bailouts, and it would be mostly targeted at helping help the most affected parties. The parties most disrupted would be well-capitalized, who are in the best position to survive the current crisis in the first place.
What am I missing here? Shouldn’t the shutdown of economic flow be addressed by minimizing the total economic flow? Isn’t that better than having the government print money and try to replace, piecemeal, the missing economic flow? I feel as if nobody in government has thought this through beforehand. What were they thinking would happen if their public health officials demanded an overnight shutdown of the economy? What was the economic plan that was to go along with enforced social distancing?
While I usually respond in haiku, this comment caught my attention. You’re logic is sound, however the key variable missing from your equations are that money is not a physical good. It’s a theoretical concept.
The value that anything receives, whether it is a dollar bill, a bar of gold, or a “cute” girl/guy at the adjacent table is dependent on one thing: agreement on the assigned value. The founder of Jones soda once said “No one needs our product.” That is true. The value assigned to that product is a feeling: the anticipation of the purchase, the purchase itself, the consumption of the product, and the memories of the experience. Should that product have an objective result, such as medicine, than the value is assigned by those who want that result.
When the central bank floods the market, they are trying to sell you a feeling of parental comfort. Historically, it has been an effective tool but in the modern era, we have created a new reference point. Therefore, when the same tools are used, we don’t agree on the same value of that parental comfort and the tool becomes less effective.
Shutting down an economy means that the reference point, the agreed upon value, is eliminated entirely. Almost immediately an underground barter economy would form because we as living beings still need to exchange goods and services for other goods and services. We would just end up creating our own agreed upon values.
So this problem is really one of systemic confidence in a stable reference point and the agreed upon value. What we’ve seen over the last decade is a focus on paying for confidence of present values with anticipated future values (that’s called a bubble.) What we are seeing now is a hoarding of items that have standard agreed upon values because of their utility (eg: toilet paper), which is quickly being regulated because it does not serve the public to have the valuations so high.
It’s a very complex, arguably biological system. There is no right economic answer other than what people believe is the right answer. The wrong answers are the ones that economically benefit select groups of people, or, cause literal biological harm (such as not enforcing social distancing.)
Welcome to 2020.
Nicely put.
Good luck everyone, and be good to each other.
I have nothing but respect for our health officials..I only have one question to ask and I hope there is no back lash here, I do have an aging mother who I worry about. I’m not completley heartless.. but was there an economist in the room when the decided to go this route..?
I’m confident that countries around the world did not universally forget about the economic impacts when they decided to shut things down.
“Wuzzzah? It’s bad for business? Man, didn’t think of that.”
ICE condos banning Air B&B due to transient resident dangers
ICE must have 1000s of units, and many more condo associations could/should follow.
“There are laws on the books, there is a global pandemic, you must cease operations immediately,” Thorben Wieditz of Fairbnb said he’s hearing from residents.
https://www.toronto.com/news-story/9916377–risk-of-danger-to-residents-prompts-some-toronto-condos-to-ban-airbnbs-amid-coronavirus-crisis/
At this time, some very large Condo boards have BANNED SHORT TERM RENTALS, due to residents fearing the health risks. This contagion will likely spread…
Artificial in the Star, march 25th