Poloz’s caution on rates ‘a mistake,’ predecessor says
Dodge thinks BoC should focus more on stability amid risk of rising debt
OTTAWA One of governor Stephen Poloz’s predecessors says the Bank of Canada’s current approach to increasing interest rates is too cautious.
David Dodge, who led the central bank between 2001 and 2008, thinks Poloz should focus more on the long-neglected issue of financial stability and take the opportunity to raise rates now that the economy is running more or less at potential.
Poloz kept his benchmark rate at one per cent last week and indicated he’s in no rush to tighten, given that he still sees signs of wage and inflation slack.
Keeping borrowing costs low will only encourage households and businesses to keep adding debt, risks that should factor in more to the central bank’s decision making, Dodge said.
“While I understand why they want to be cautious, and I think that’s quite correct, the fact that they are not moving to deal with what is a problem in financial markets arising from this very long period of very low interest rates I think is a mistake,” Dodge said.
Interest rates could rise by a full percentage point and still remain well below the three per cent the Bank of Canada estimates is “neutral” for the economy — neither stimulative nor contractionary.
“It’s not like the bank is being unreasonable,” said Dodge. “Theirs would be more or less the mainstream view, whereas I put a little bit more emphasis” on financial system distortions. “I’ve lived through earlier periods,” he said, in reference to the financial crisis.
While government debt levels are low, Canada has by far the most private sector debt relative to GDP in the Group of Seven.
“If we think we are actually growing at about the capacity of the economy and are pretty much balanced, then indeed we should have rates that are higher than they currently are,” Dodge said.
Poloz has cited the economy’s increased sensitivity to higher interest rates as one reason to remain cautious, but he wouldn’t be drawn on whether the new spending measures were stimulative.
The Bank of Canada’s latest credit data show growth in debt financing is slowing from elevated levels earlier this year. Still, 2017 is on pace for the strongest year since the 2008-09 recession.
Total business and household credit in the economy reached $4.08 trillion in September, 7.2 per cent above year-ago levels.
The rise is mostly due to a surge in borrowing by businesses, which have increased credit by 9.1 per cent from a year ago, accounting for 60 per cent of all credit taken out in the economy over that time.
That could be a good thing if it means companies are financing investments. Since corporate borrowing is rising faster than investment, however, it may suggest instead that companies are taking on debt to fund share buybacks or higher dividends, Dodge said. The debt baton is simply being passed from one sector to another.
“The bank talks about the household sector, which is worrisome,” Dodge said. “But we also have a number of corporations which are overextended, which is also quite worrisome from the perspective of future macro financial stability.”
The rising level of business credit may reflect a number of other things as well. According to Doug Porter, Bank of Montreal chief economist, economic data show companies have also been ramping up inventories this year, which needs to be financed.
They are also in the process of repairing income statements, after a tough couple of years of profits, and may need some debt to get investments going.
“We might be at the stage of the cycle where businesses do need a bit of financing to support modest increases in capital spending,” Porter said. “But perhaps a year from now as earnings grow they won’t need as much external financing.”