Let's cut to zero too

OK, the US Federal Reserve has now cut interest rates essentially to zero. I think the Bank of Canada should now do the same.

On Thursday December 4, I recommended the Bank cut the overnight rate to 1%; it did cut the following Tuesday, but only to 1.5%. The longer you wait before cutting, the more you have to cut, because demand gets even weaker if you don't cut enough.

The Canadian economy has been much stronger than I would have expected, until recently. That has now changed. The weak employment numbers on Friday December 5, are the most important signal, but weak housing starts, falling home sales, and falling house prices are confirmation. The Canadian economy has been stronger than the US, but is now following the same path, with a lag. We should be grateful for that lag, because it gives the Bank of Canada a chance to get ahead of the curve.

The Federal Reserve's decision affects Canada. If US rates fall, and Canada's stay the same, and are expected to stay the same, this will create pressure for the Canadian dollar to appreciate (it appreciated by 2 cents this afternoon), which would weaken demand in Canada. We need to match the US cut, and we might as well go to zero, since the Fed clearly wishes it could go below zero (that's why it's talking about quantitative easing).

We will know that the Bank of Canada has cut enough when people are more scared of inflation than deflation. That's what we need to achieve, so they will spend their cash now, while it's still worth something.

Comments

[brendon]

I have to agree - just might be time for a kitchen sink policy - zero rates + large fiscal stimulus.

[Nick Rowe]

I can't decide about the fiscal stimulus. But I think fiscal policy will be needed if the Bank doesn't cut very aggressively very soon.

[Adam]

And the money I'm saving for my down payment in a year or two? If we decide that inflation is a great thing, I might as well kiss it goodbye. Maybe the government should just requisition it, like foodstuffs for an army in time of war. My fault for not blowing it on consumer goods.

[Nick Rowe]

Adam: and that is exactly the sort of belief that I want to create. I want people to fear inflation more than deflation, so they will dump money, and safe government bonds, and safe little bank accounts, and buy real assets like stocks, refrigerators, even cans of beans! The proximate cause (not the original cause, but that horse has bolted) of the financial crisis is that everybody wants to hold the very safest, shortest, and most liquid assets: money and government bonds. The solution lies in making those assets undesirable enough that people will want to get rid of them.

[Chris]

I'm still concerned that not enough of that stimulus will get passed on to the consumer, as the days of discounted variable rate mortgages are past. I agree that it's warranted, but it frustrates me to see the banks profit off it.

I agree with your comments to Adam though, if it's enough to create spending it'll do it's job. What I fear is the media spinning it the opposite way and reducing the impact.

[seaandthemountains]

for someone with an extremely limited knowledge of economics, my first reaction to discussion of the reduction of interest rates is considerable confusion. working from the suggestion that the current situation results at least in part by people and companies being over-leveraged, does lowering interest rates, following up on efforts to ensure that credit is available, not play into repeating that very phenomena?

[Nick Rowe]

^ I don't know. I have been thinking about that question. I guess it depends who does the extra spending. Remember: in aggregate leverage is zero. If A has borrowed from B to invest, then A is leveraged, but B is "anti-leveraged". In aggregate, debt is zero.

[TigerPaw]

And for those people that don't need more "stuff" just what the heck are we supposed to do if we have saved some money for our old age. Just burn it in the fireplace? That's what the wonderful goal of inflation means.

[TigerPaw]

Apologies for multiple post. Network had a problem.

[No worries; I've deleted the extras. SG]

[seaandthemountains]

You are right Nick. But thinking about it that way feels like we might be setting some people up to end in hard spots as a means of stimulating the economy. I suppose that to the degree we do a better job of regulating who has access to how much credit I suppose we mitigate that to some degree. My concern though, is that for all the talk/debate we heard re: the limits of the regulation of the market as the market first started going pear shaped, that discussion seems to be less prominent in the wake of the multiple bailouts that have been/are being developed and implemented.

[Nick Rowe]

Wheat prices need to go up and down to keep the supply of wheat balanced with the demand for wheat. When wheat prices go up, this is good for wheat producers and bad for wheat consumers. Vice versa when wheat prices fall.

Real interest rates (nominal interest rates minus inflation) need to go up and down to keep aggregate supply balanced with aggregate demand. When real interest rates go up, this is good for lenders and bad for borrowers. Vice versa when real interest rates fall.

[Canada life insurance]

Why it's so widely believed that some central bank can control the economy like in some PC game?? Rates down, rates up, everything is fine... This crisis was caused by extremely low FED rates back in 2002, when they were trying to kick start the economy after bubble dot crash, it caused artificial real estate boom, it caused boom of sick investments, which are now collapsing like the house of cards and the same mistake is done again and again...do you really think when somebody in the Bank of Canada will press the button "cut rates", everything will be miraculously fine?? I wish so, but this will just push the problems for some months, but they will be soon back and even bigger. Are we going to cut the rate forever? what will we do, when we reach 0% and the recession will be still here?
Regards,
Lorne

[Nick Rowe]

Lorne: have a read of my later "Hair of the Dog" post, which sort of addresses your question.

[KenHoughton]

Just peg to the bleeding Mark—er, EUR—and get it over with already!