On the Issues

The interest rate soap opera

Will Gordon help David? What will Paul think? Tune in next week.

Mary Janigan January 22 2001
On the Issues

The interest rate soap opera

Will Gordon help David? What will Paul think? Tune in next week.

Mary Janigan January 22 2001

The interest rate soap opera

On the Issues

Will Gordon help David? What will Paul think? Tune in next week.

Mary Janigan

For the elite governing council of the stately Bank of Canada, this is a tricky time. Before next Tuesday, Jan. 23, at 9 a.m., its seven members, including central bank governor Gordon Thiessen, must decide where they think the Canadian economy is heading—and what they want to do about it. Normally, such sessions to establish the key bank rate are dull affairs, certainly not stirring enough to rattle a teacup at the banks palatial headquarters near Parliament Hill. But at this session, the stakes are high. This is the last gathering that Thiessen will chair before his successor, David Dodge, takes over on Feb. 1.

Will Thiessen want to tinker with the rate of six per cent before the new governor decides what he wants to do?

Worse, although the health of the economy could be teetering in the balance, economists cannot even agree on the direction that the bank rate should take.

Should it go up, down or stay the same? Seen in isolation, the Canadian economy seems fairly healthy. Growth remains relatively strong—although private forecasts for 2001 have been edging steadily downward. The unemployment rate even dropped, to 6.8 per cent, in December. And Finance Minister Paul Martin is counting on major tax cuts, which took effect on Jan. 1, to stimulate domestic demand.

But the clear signs of a rather drastic U.S. slowdown have spooked many experts—if only because the United States, at last tally, took a whopping 83 per cent of Canadian exports. (And exports in total represent fully 43 per cent of Canadas GDP) “Canada has been playing catch-up with the United States, always 18 months to two years behind, all through the 1990s,” observes University ofWestern Ontario economist David Laidler. “So the new governor must somehow manage the Canadian economy so that it gets through the next 18 months to two years, still expanding, while the United States goes through its downturn. That is going to be really difficult.”

So what’s a governor to do? A minority of economists point to Canada’s November inflation rate of 3.2 per cent— which is slightly beyond the target range of one to three per

cent—and argue that Canada should increase its bank rate. At the very least, it should stay the same. “The new governor can’t play Santa Claus with money and credit,” warns William Robson, vice-president of the C. D. Howe Institute, who would raise rates by a quarter of a percentage point to ease demand and lower inflation.

In contrast, many economists think the U.S. slowdown is more than enough to cool off the economy—and that

rates should be lowered as a precaution. They believe the more important gauge is the so-called core inflation rate— that is, the rate minus the effect of energy and food prices, as well as indirect taxes. The core rate is only 1.8 per cent. And they warn that the bank had better move soon if it wants to fend off serious trouble. “There has been a tendency in the past to wait too long to start lowering interest rates when the economy starts to fade,” says Ted Carmichael, chief Canadian economist for J. P. Morgan Chase & Co.

And there’s the rub. A former deputy finance minister, Dodge got the job despite the fact that Thiessen favoured senior deputy governor Malcolm Knight, a member of the governing council. As a result, some finance department officials harbour deep suspicions that the bank will be less than helpful to Dodge—if only because he is an outsider. Meanwhile, many private forecasters already suspect that both Dodge and Martin are less concerned than the bank’s governing board about meeting those crucial inflation targets. If the governing council leaves the bank rate unchanged on Jan. 23, it might look bad if Dodge promptly lowers it next month. “There will definitely be a cut within the next six weeks,” predicts Don Drummond, chief economist at the Toronto Dominion Bank. “True, it’s hard to lower just now because the Canadian economic data is pretty strong. But it may not be the best thing if the very first thing that David Dodge does is to lower rates. It would be a nice gift if Gordon Thiessen actually did that for him.” Keep watching: in effect, monetary policy has become a high-stakes, high-brow soap opera.