The Dangers of an Extended Period of Low Interest Rates: Why the Bank of Canada Should Start Raising Them Now
AbstractInterest rates in Canada and in many other countries have not been so low since the Great Depression. When taking into account inflation, short-term interest rates are negative in most developed countries, including Canada where the overnight rate currently stands at 1 percent in nominal terms. These historically low rates were initially a response to the global financial crisis that broke out in 2008. The financial crisis led to a sharp fall in economic activity, a dislocation of the financial system, and the need in many countries to recapitalize banks with public money. Output growth has resumed in the United States, but unemployment remains unsatisfactorily high. In the European Union, the recovery has been hampered by high public debt and fears of a breakdown of the euro area. Canada however does not face the same problems as either the United States or the EU. Its financial system was exposed to a much lesser extent to complicated sub-prime, mortgage-backed securities, and its economic difficulties are nowhere near as pronounced. The current downturn of output compared with its potential, although significant, has been less severe in Canada, and gross domestic product (GDP) has returned to a value closer to the economy’s capacity. In this Commentary, I argue that short-term rates are therefore too low in Canada, a situation that is starting to build in pervasive problems for the economy. Below-equilibrium interest rates for an extended period distort investment decisions, leading to excessive risk taking and inefficient and ultimately unprofitable investments. They also encourage the formation of asset bubbles whose collapse could lead to a recurrence of the recent financial crisis. Some of the symptoms of inefficient investment and asset price bubbles are already evident in Canada, in the housing sector for instance. The cumulative effect of artificially low interest rates also risks fuelling an underlying inflationary process. Therefore, I recommend that the Bank of Canada start now to reverse some of the monetary stimulus and begin raising interest rates.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by C.D. Howe Institute in its journal C.D. Howe Institute Commentary.
Volume (Year): (2013)
Issue (Month): 381 (May)
Monetary Policy; Interest Rates;
Find related papers by JEL classification:
- E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- David Laidler, 2011. "Natural Hazards: Some Pitfalls on the Path to a Neutral Interest Rate," C.D. Howe Institute Backgrounder, C.D. Howe Institute, C.D. Howe Institute, issue 140, July.
- Hahm, Joon-Ho & Mishkin, Frederic S. & Shin, Hyun Song & Shin, Kwanho, 2011.
"Macroprudential policies in open emerging economies,"
Proceedings, Federal Reserve Bank of San Francisco,
Federal Reserve Bank of San Francisco, issue Nov, pages 63-114.
- Joon-Ho Hahm & Frederic S. Mishkin & Hyun Song Shin & Kwanho Shin, 2012. "Macroprudential Policies in Open Emerging Economies," NBER Working Papers 17780, National Bureau of Economic Research, Inc.
- Bo Becker & Victoria Ivashina, 2013. "Reaching for Yield in the Bond Market," NBER Working Papers 18909, National Bureau of Economic Research, Inc.
- Joe Peek & Eric S. Rosengren, 2005.
"Unnatural Selection: Perverse Incentives and the Misallocation of Credit in Japan,"
American Economic Review, American Economic Association,
American Economic Association, vol. 95(4), pages 1144-1166, September.
- Joe Peek & Eric S. Rosengren, 2003. "Unnatural Selection: Perverse Incentives and the Misallocation of Credit in Japan," NBER Working Papers 9643, National Bureau of Economic Research, Inc.
- William Scarth Author- Workplace-Name: McMaster University, 2014. "User Discretion Advised: Fiscal Consolidation and the Recovery," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 412, July.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kristine Gray).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.