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The Bank of Canada (BoC) announced Wednesday that it would slash interest rates by 0.25 percent to a near record low of 0.7 percent amid declining oil prices and threats to unemployment and household debt levels. BoC Governor Stephen Poloz referred to this move as an “insurance” policy against a weak economy.
Since the monetary policy decision, financial experts have purported that it’s quite possible the central bank could cut interest rates again sometime this year, a move that would surely stun markets even more and encourage consumers to borrow large sums of money for automobiles, big screen televisions and home renovations.
During the first half of 2015, the Canadian gross domestic product is expected to slow to 1.5 percent and then jump to 2.5 percent for the second half of the year. Inflation, meanwhile, is projected to tumble further this year and stay below its two percent target rate.
“Policy insurance is a logical part of our risk management framework,” said Poloz in a statement. “Today’s action is intended to reduce the risk that our inflation path might move materially to the downside, as well as cushion the impact of lower oil prices and facilitate the economy’s sectoral adjustment to its new circumstances. The Bank has room to maneuver should its forecast prove to be either too pessimistic or too optimistic.”
Although the central bank has warned previously about astronomical household debt levels and an overheated housing market, Poloz encouraged consumers to not borrow further and take on greater sums of debt – this is counterintuitive and a rate hike will only prompt consumers to refrain from being further indebted.
The loonie fell to a six-year low against the United States dollar, while the Toronto Stock Exchange (TSX) jumped 1.8 percent on the news, though hardly anyone expected such a policy move.
Where do we go from here?
Poloz may be attempting to depict himself as a sapient professional, but this type of Keynesian measure will only do more harm than good. The tidal wave of unintended consequences will significantly hinder an already timid national economy, which has been hurt by falling oil prices for the short-term.
Ostensibly, it appears that political leaders and central banks awoke from an insouciant state amid the shale revolution that won’t last long. All what Canada had to do was ride the storm and wait several months until oil prices stabilized – remember, shale oil is very expensive to produce, hence why so many U.S. companies are cutting jobs, closing down operations or filing for bankruptcy.
Nevertheless, the BoC moved ahead with a rate cut. An array of consumers have been airing their expostulations, while the elite have been amiable. We have to realize that manipulating interest rates will only create distortions and malinvestments and further contribute to the boom-bust cycle.
This is further proof as to why Canada – and other nations – need to adhere to a market interest rate. Similar to prices, an interest rate can tell a lot about an economy because it sends signals to consumers, governments, financial institutions, lenders and businesses. It informs the market that people are saving or spending, if businesses are expanding or scaling back.
In addition, a decrease in interest rates will only further advance Canadians’ debt levels. Consumers in the Great White North have an average “unsustainable” debt load of $27,000 and they aren’t taking any significant steps to decrease this level of indebtedness. Perhaps a rate hike would prompt them to start taking action.
Poloz wants to spur economic growth through consumption, but debt-induced consumption doesn’t create any genuine economic growth. An economy grows only through savings and investments, while consumption is done through the savings and investments that were produced in the first place.
The perspicacity of consumers is that since they have to pay relatively low interest on their debt for quite a longtime then they can boost their lines of credit, take on more credit card debt and apply for a mortgage they can’t even afford.
Speaking of housing, the Canadian housing market is said to be overvalued by 60 percent. This is surely one way to enhance the housing bubble from Vancouver to St. John’s and prevent it from going through a market correction. Just think when the bubble does burst.
Despite believing they’re the smartest men in the room, no one man or group can determine what the proper interest rate can be in an economy of 35 million people. Clearly Poloz has an atavism of his predecessor, Mark Carney, in thinking that the only way to boost the Canadian economy is through artificially suppressed rates.
Finance Minister Joe Oliver told CBC News that he was not informed of this rate cut prior to traveling to Davos, Switzerland for the World Economic Forum. However, one can only surmise that it’s more than just a coincidence that Canada is an election year, and lower interest rates can only benefit the incumbent political party.
Unfortunately, even if Liberal leader Justin Trudeau enters office in this autumn, he’ll further support such Keynesian economic policies that led to today’s financial destruction on a global level.
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