With interest rates cut to a record low Tuesday and inflation nowhere in sight, Bank of Canada looks to boosting money supply

KEVIN CARMICHAEL

From Wednesday’s Globe and Mail

March 4, 2009 at 3:25 AM EST

OTTAWA – Bank of Canada Governor Mark Carney is rearming to fight a recession that is proving tougher than the central bank anticipated.

Mr. Carney cut the benchmark mark lending rate by half a percentage point yesterday, dropping the target for overnight loans to 0.5 per cent, the lowest ever.

By taking borrowing costs so close to zero, Mr. Carney effectively fired his last round of conventional monetary stimulus, forcing him to consider taking a more aggressive approach to easing credit markets.

The Bank of Canada said in the statement explaining its interest rate decision that it is “refining the approach it would take to provide additional monetary stimulus, if required, through credit and quantitative easing.”

Such a strategy amounts to creating money, a radical thought for an institution that has spent much of its modern history trying to earn its credentials as a committed inflation fighter.

But inflation isn’t a threat at the moment.

The Bank of Canada said yesterday that consumer price decreases are accelerating even though the bank has dropped the overnight target a remarkable four percentage points since December, 2007.

Canada’s gross domestic product contracted at an annual rate of 3.4 per cent in the fourth quarter, marking the biggest collapse since 1991 and one that was worse than the central bank had predicted in January.

“The central bank is doing the right thing; they have to be aggressive,” said Barry Schwartz, vice-president of Toronto-based Baskin Financial Services Inc., which has about $275-million under management. “People are freaking out. No one is spending money, so the government has to do it.”

The Bank of Canada didn’t provide details of what a quantitative easing or credit easing strategy would look like, saying those will come in the central bank’s next quarterly monetary report on April 23.

Pierre Duguay, a deputy governor at the Bank of Canada, could elaborate on the central bank’s plans tomorrow in testimony at the House of Commons finance committee, which is studying credit conditions. More details also could come when David Longworth, another deputy governor, speaks to the Financial Markets Association of Canada in Toronto on March 12.

Generally, quantitative easing would see the central bank expand its reserves to buy a wide range of assets, while credit easing describes an effort to target specific markets.

Other central banks already are deploying these strategies.

The U.S. Federal Reserve is running several programs that swap cash for illiquid assets, such as securities backed by mortgages and student loans, and is considering buying government debt to lower market lending rates.

News reports out of London yesterday suggested British Prime Minister Gordon Brown’s government is poised to give the Bank of England permission to print money. The Bank of Japan is buying corporate bonds.

“One way for the monetary authority to show its long-run confidence is to buy some of these assets,” said John Helliwell, an economics professor at the University of British Columbia and former adviser at the Bank of Canada. “That will drive down the price of those assets, and hopefully people will go out and buy some more.”

The Bank of Canada hasn’t ruled out cutting the overnight target all the way to zero, saying the rate “can be expected to remain at this level or lower at least until there are clear signs that excess supply in the economy is being taken up.”

That means rock-bottom borrowing costs for at least a year, said Sébastien Lavoie, an economist at Laurentian Bank of Canada in Montreal.

In the statement, the central bank said the effects of its previous interest rate cuts will start to show up in the second half of the year.

At the same time, policy makers conceded that a rebound is contingent on calmer global markets and an end to the U.S. recession. “The Bank of Canada is going to keep the overnight rate at a very low level for a very long period,” said Mr. Lavoie, a former Bank of Canada economist.