August 28, 2014 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada keep its target for the overnight rate, the very short-term interest rate it targets for monetary policy purposes, at 1.00 percent at its next announcement on September 3, 2014. Looking ahead, the Council called for the Bank to hold the target at 1.00 percent through the spring of 2015, but called for a target of 1.50 a year from now.
The MPC provides an independent assessment of the monetary stance appropriate for the Bank of Canada as it aims for its 2 percent inflation target. William Robson, the Institute’s President and Chief Executive Officer, chaired the Council’s 88th meeting.
MPC members make recommendations for the Bank of Canada’s upcoming interest-rate announcement, the subsequent announcement, and the announcements six months and one year ahead. The Council’s formal recommendation for each announcement is the median vote of the members attending the meeting.
Nine of the ten MPC members attending this meeting called for a 1.00 percent target at the upcoming announcement and at the subsequent announcement in October, while one called for a 0.75 target at both. Looking ahead to the March 2015 setting, seven members favoured a target of 1.00 percent, while two voted for 1.25 percent and one for 1.50 percent. The range for the September 2015 setting was three members wanting 1.25 percent, three wanting 1.50 percent and four wanting 1.75 percent.
The group generally took a positive view of Canada’s current economic performance, expecting a solid reading for second-quarter real GDP (a key economic release between the MPC meeting and the Bank of Canada’s announcement), continued progress in closing the gap between actual and potential output, and inflation expectations well anchored at the Bank’s 2 percent target. Looking abroad, members noted that disappointing news out of Europe and Japan was more than balanced by positive US growth. While some members noted that the Canadian dollar looks higher than Canada’s terms of trade would support, many expected improvements in net exports and more buoyant business investment to complement continued spending growth on the part of Canadian households in the months ahead.
In drawing conclusions about the conduct of Canadian monetary policy, however, the group wrestled with two major types of questions: about the size, duration and even the significance of the output gap; and about the “normal” level for the overnight rate – the rate that would be appropriate if the output gap were zero and inflation were at 2 percent.
In addition to long-standing problems with estimating the output gap from current economic data, and differing views – especially about how rapidly Canada’s potential output is rising – the group noted that estimates of the output gap, especially recently, do not appear well correlated with changes in inflation. While most members thought that economic models relating changes in inflation to the output gap had value, the majority had reservations about too heavy an emphasis on it, and one member highlighted the possibility that changes in inflation expectations driven by other indicators might move the inflation rate abruptly off target.
As for the normal level of the overnight rate, the group discussed a number of factors, notably demographic shocks that have increased desired saving, and might have reduced global interest rates. While the uncertainties about these forces and their impact on interest rates precluded agreement on the size of the effect, the view that the neutral level of the overnight rate is lower now than in the past helps account for the very subdued increases in the overnight rate MPC members called for over the coming year.
The following table shows the votes of each MPC member, as well as the Council’s median vote, for the relevant Bank of Canada policy-rate announcements.