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My view, for what it's worth, is that the Bank should take it slow, because:

1. Given that interest rates are already very low, and the fiscal deficit is already very high, any relapse into a double-dip, though unlikely, would be very problematic. Better to err on the side of being too loose than too tight in current circumstances.

2. The exchange rate is already doing a lot of monetary tightening, and it's the exchange rate, not the interest rate, that should be taking most of the load, if the US economy in particular still looks much weaker than Canada's.

3. Fiscal policy is already very loose, and ought to be tightening soon. We ought to be tightening fiscal policy first, then monetary policy second.

4. God only knows what's going to happen in the Eurozone. And how that will affect Canada.

I'll second most of what Nick said, but just because CAD is appreciating against foreign currencies doesn't mean there can't be domestic inflation. I'd prefer to err on the side of tighter monetary policy.

The announcement itself has pushed the CAD over parity in the space of 90 minutes.

Given that stimulus spending is going to continue into March 2011 (source: http://www.cbc.ca/money/story/2010/04/19/liberals-stimulus-deadline.html), we are now going to enter a 9-month period of contractionary monetary policy and expansionary fiscal policy. To me that's something we should be concerned with.

I don't think it is a good idea to raise rates, because fiscal policy is threatened to be tightened.

With 8%+ unemployment, I wouldn't worry too much about domestic inflation.

Am I correct in assuming that Nick et. al are worried about government debt and deficits getting to the point where we are forced to raise rates when we'd otherwise wouldn't want to?

I suspect the government (whoever it is) will take a BIG chunk out of defence spending once we get our people home from Afghanistan. That'll help some, but I don't see how we can get away with not raising taxes. Hopefully someone will grow a pair and either raise the GST or impose a carbon tax, but I'm not holding my breath.

@Patrick Unemployment and inflation have almost zero correlation. The 1970s should have proved that once and for all. The UK just posted a spike to 3.2% and they're much worse off employment wise than we are.

@crf The stimulus and other fiscal moves are such a small percentage of the overall economy that cutting them now would have almost no effect.

Christopher: "Unemployment and inflation have almost zero correlation"



Patrick: "Am I correct in assuming that Nick et. al are worried about government debt and deficits getting to the point where we are forced to raise rates when we'd otherwise wouldn't want to?"

Not really. That argument might work for places like Greece, which can't print money. Or for any country that issues debt denominated in foreign currency. But for Canada, the Bank of Canada could buy the bonds, if we wanted to increase aggregate demand, and nobody else would buy the bonds at a low enough rate of interest.

I'm more concerned about future taxes. It's the tax-smoothing argument. Ideally, we don't want big anticipated changes in tax rates. It distorts economic activity more than constant tax rates would. The longer we run a deficit, the bigger the debt, and the bigger the eventual jump in tax rates would have to be when we finally do raise taxes.

Plus, there's the precautionary argument. Having a low debt/GDP ratio means there's lots of borrowing room in any future emergency.

@Patrick In the first paragraph of the philips curve: While it has been observed that there is a stable short run tradeoff between unemployment and inflation this has not been observed in the long run.

In the NAIRY article: During the 1970s in the United States and several other industrialized countries, Phillips curve analysis became less popular, because inflation rose at the same time that unemployment rose. (See stagflation.) Worse as far as many economists were concerned, the Phillips curve had little or no theoretical basis. Critics of this analysis (such as Milton Friedman and Edmund Phelps) argued that the Phillips curve could not be a fundamental characteristic of economic general equilibrium because it showed a correlation between a real economic variable (the unemployment rate) and a nominal economic variable (the inflation rate). Their counter-analysis was that government macroeconomic policy (primarily monetary policy) was being driven by a low unemployment target and that this caused expectations of inflation to change, so that steadily accelerating inflation rather than reduced unemployment was the result. The resulting prescription was that government economic policy (or at least monetary policy) should not be influenced by any level of unemployment below a critical level - the "natural rate" or NAIRU.

OK, maybe my statement on correlation was a bit heavy, but those articles point much closer to monetary policy and productivity effecting the rates of inflation much more than employment itself (and there is a correlation between those). During the 1990s many high paying tech jobs were created and unemployment was low, but overall the inflation level was low.

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