TORONTO (Reuters) - The newly found ability for central banks to have negative policy interest rates diminishes the need for them to raise their inflation targets, a Bank of Canada discussion paper concluded on Friday.
The article was released simultaneously with a speech by the bank’s senior deputy governor, Carolyn Wilkins, in which she reiterated the stance that Canada’s inflation-targeting framework was working well, “so the bar for change is high.”
The text of the speech made no reference to current monetary policy and the paper noted that the views do not reflect its official bank policy.
Next year, the central bank and the Canadian government will renew the bank’s five-year inflation-targeting mandate, which currently tries to keep inflation at 2 percent.
Wilkins said given reduced growth potential, the neutral rate of interest is lower than before the global financial crisis. This suggests it is more likely now that policy interest rates will fall to zero if the inflation target is kept at 2 percent, limiting the margin for conventional monetary policy.
But the Bank of Canada research paper, to which she referred in her speech, found that negative policy interest rates restore some maneuver room.
“To the extent that policy interest rates can be reduced meaningfully below zero temporarily with limited costs to financial stability, arguments that the inflation target should be raised in response to a lower neutral interest rate become less powerful, particularly given the costs that permanently higher inflation poses,” the paper said.
However, analysis was needed on whether negative rates are a viable tool over an extended time, and also on how low rates can go, it said.
It therefore remained an open question as to whether the ability to have negative policy rates, effectively charging banks for their deposits, can sufficiently compensate for the decline in the neutral interest rate, the paper said.
Wilkins said the research found that transmission of negative policy rates through the exchange rate channel “might be particularly important.” That was a reference to negative rates weakening the domestic currency.
In a separate Globe and Mail newspaper interview, Wilkins referred to a lower Canadian dollar helping a Canadian recovery, aided also by U.S. growth and past rate cuts.
“What we are seeing is the rebound in the second half [of 2015] that we were looking for,” she said.
Wilkins also told the Globe she expected a soft landing for the heated housing market.
Writing by Randall Palmer; Editing by Chizu Nomiyama and Bernadette Baum