– The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies through research that is nonpartisan, evidence-based and subject to definitive expert review.
CANADA – Expanding the money supply is the best option for the Bank of Canada in a low interest rate environment, states a new report from the C.D. Howe Institute. In “Putting Money to Work: Monetary Policy in a Low Interest Rate Environment,” author Steve Ambler suggests that it should use quantitative easing (QE) to increase the broad money supply, on a longer term rather than a temporary basis, to encourage spending on goods and services by individuals and firms.
“Depending on the performance of the Canadian economy and the outlook for inflation, the Bank of Canada may, in the near future, decide to lower its overnight rate target to 25 basis points,” states Ambler. “At that point, its scope for further easing of monetary policy by lowering interest rates becomes quite limited as it hits an effective lower bound,” he adds.
Governor Poloz signaled the possibility of using negative interest rates but how low they can go is limited. Further down the road, therefore, the Bank may then be faced with the necessity of providing monetary stimulus without lowering rates, and should consider using QE to affect spending by acting to expand the size of the money stock.
QE involves open market purchases of government securities from banks or from the private sector. Buying securities from banks increases the cash balances they hold at the Bank. Banks can then use these balances to expand lending, which increases deposits held by their customers and thereby expands broader measures of the money supply.
Purchases of securities from the private sector expand bank deposits and broad money directly. These in turn encourage increased spending on goods and services without necessarily having to lower interest rates.
According to Ambler, “the Bank of Canada should aim to provide monetary stimulus through open market operations or through direct purchase of securities from the private sector.” However, this may require some rethinking of the way monetary policy is currently conducted.
Currently, the Bank’s operating procedures, particularly the goal of achieving close to zero net settlement balances each day, seem almost designed to eliminate the possibility of permanent increases in the monetary base via open market operations.
The report suggests that the Bank should think carefully about how to adapt these operating procedures in an environment with a zero or negative overnight rate before it finds itself stuck there in a so-called “liquidity trap.” Further, the Bank should also devote some resources, after what has been a long hiatus, to looking at the informational content and economic significance of monetary aggregates.
“Increases in the money supply can have powerful real effects even at very low interest rates,” concludes Ambler.
