The Central Bank’s Dilemma
Former Bank of Canada Governor Stephen Poloz recently shared his thoughts on the limits of monetary policy in the face of COVID-19. During an interview at Bloomberg’s virtual Canadian Fixed Income Conference, he emphasized that the central bank has done most of what it can do to stimulate the economy.
The Limits of Monetary Policy
According to Poloz, monetary policy is near its limits and fiscal policy should be the primary tool for lifting the economy out of the hole created by COVID-19. The Bank of Canada has done a great deal to support the economy through low interest rates and quantitative easing, but it’s now up to fiscal policymakers to take on a more significant role.
Fiscal Policy Takes Center Stage
Poloz noted that as the economy returns to normal, cash will flow back into the system, and the Bank of Canada’s balance sheet will shrink automatically. The main question is how sustainable is the debt being drawn down by governments?
Debt Service Issue
A recent report by the International Monetary Fund estimated that Canada’s general government gross debt will rise to 115 per cent of gross domestic product this year, from 89 per cent in 2019. Poloz acknowledged that policy makers don’t have much experience with such large numbers but suggested that provided interest rates stay low, it’s more of a "debt service issue."
Sustainability Criterion
Poloz emphasized that the sustainability criterion can be met if the government money is used for productive reasons and enhances the ability of the economy to grow. He believes that in real terms, interest rates are likely to stay low for a generation.
Good Fiscal Policy: A Lifeline
Poloz highlighted the importance of good fiscal policy in avoiding the need for negative interest rates, which he described as "a good thing for everybody." He cited daycare as an example of social infrastructure that could be put in place by the government to help the economy grow in the longer term.
Negative Interest Rates: A Last Resort
Poloz noted that negative interest rates have only really been used in economies where fiscal policy was failing to provide a solution, particularly in Europe. He added that while they remain in the central bank’s toolkit, monetary policy has already done most of what it can do.
Conclusion
In conclusion, Poloz emphasized the need for fiscal policymakers to take on a more significant role in lifting the economy out of the hole created by COVID-19. He highlighted the importance of good fiscal policy and warned that negative interest rates should be seen as a last resort.
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