Friday, July 19, 2013

Poloz’s First BoC Interest Rate Statement

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Bank of Canada Governor Stephen Poloz said that interest rates will remain low and the economy will grow due to “accommodative financial conditions.” His logic goes: The US economy is recovering ergo Canadian exports will grow therefore solid Canadian business investment will occur. He admits that there are “modest declines” coming in real estate but the GDP will act as a cushion for a rein in on consumer spending, or “material excessive capacity.” Poloz fails to see how real estate is tied into the broader economy, so that a significant decline in prices will have adverse effects in consumer spending. Also, the US economy is not recovering.

According to Poloz’s logic, since export businesses face competition abroad, it’s better to wait until the US economy recovers so that a “weak” loonie looks appealing. Forget trading with other countries and using a strong currency to lower capital costs and naturally bring down interest rates. Poloz doesn’t even mention this and no journalist asks him. Poloz’s first statement as head of the BoC didn’t offer too much in the way of solid reasoning, but he did give good insight into how the BoC conducts economics.

When Poloz spoke of “significant slack” in the Canadian economy, he made this statement based on an array of indexes that give statistical information about the economy. The centrepiece for the BoC’s economic modelling is: “capacity… or the output gap, if you like.” The output gap is modelled primarily around the labour market. According to Poloz it’s troublesome when, “the output gap appears to be a little smaller than what you’d read from the array of market indicators that you have.”

What this actually means is anyone’s guess. Poloz cautioned against his words being used as “a signal” to markets. He himself said: “That is the sum total of our best judgement at this stage. How markets react to it I’ve a long time ago given up trying to predict.” I suppose you could say that the low interest rates fuelling the credit boom are starting to show signs of malinvestment. The output gap predicts perpetual growth through printing money–  deductive reasoning insists scarcity. Nobody at the Bank of Canada understands why the models are failing.

The Bank of Canada’s policy of low rates distorts the price signals on which entrepreneurs depend. How can Canadians have a functioning economy if Poloz and his cronies are creating excessive amounts of credit?

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