Before COVID, he said inflation was moderately low in both Canada and the US, consistently running in the neighborhood of 2%, and monetary policy was nothing to worry about. The BoC and the Fed had very low rates during periods of high and variable inflation.
“Now that this is a widespread concern, it is time to refresh an old insight. Whether interest rates are lower or higher depends on what future borrowers and lenders expect. Thus, the old It’s time to update the insights as concerns spread.” Robson said.
Robson recalled how after the 2008 financial crisis, and again at the start of the pandemic, people’s expectations for the economy were so dire that some suggested the 0% policy rate was still too high. But today, an economic recovery and rising inflation are raising people’s hopes on future prices and sales, making the 0.25% target for the BOC overnight rate look low.
A good start in determining the appropriate central bank rate, Robson said, is to think of the real interest rate, or the rate of return paid by the borrower, or the rate received by the lender after considering inflation. After deducting inflation from the current policy rate, he said that the current real interest rate is less than -4%.
“If potential borrowers and lenders thought the economy was shrinking, a real overnight rate that low could stabilize things,” Robson said. “But in Canada, income and spending in the third quarter of 2020 were up 12 percent compared to a year ago. An actual overnight rate that adds fuel to that fire. ,