The Bank of Canada is gearing its research agenda toward “innovative” monetary policy able to handle a post-crisis world where conventional tools are less potent.
Speaking Friday in Toronto, Senior Deputy Governor Carolyn Wilkins said the central bank wants a better understanding of options available to policy makers when interest rates are near zero. She cited examples, currently in use in other parts of the world, such as charging banks for deposits, forward guidance and asset purchases.
“We are focusing our research firepower on the monetary policy lessons from the crisis,” Wilkins said in a speech outlining some of the Bank of Canada’s research priorities.
“Research in this area will continue, at the Bank and around the world, because the situation continues to unfold and it will take years to understand all the effects of these innovations.”
The Bank of Canada is set to renew its five-year mandate with the federal government next year, and recent speeches from Governor Stephen Poloz and his deputies have indicated there aren’t likely to be major changes to its 2 percent target.
Because potential growth rates are lower since the global crisis, targeting 2 percent inflation means “it’s more likely that policy interest rates will fall to zero than in the past,” Wilkins said.
“One important challenge for central banks now is that conventional monetary policy is stretched to its limits in some countries, where policy interest rates are at, or below, zero,” she said. “Because of this, a number of countries are using innovative monetary policy measures to return inflation to target.”
She cited Bank of Canada research released Friday that looked into the global experience of negative interest rates -- where central banks are charging commercial banks for their deposits. The evidence suggests “it’s too early to tell how effective negative rates are at creating additional demand.”
“Remember, only a few years ago, many believed zero was where monetary policy was out of bullets,” Wilkins said. “We now observe that some European countries have tested the limit.”
Evidence also suggests forward guidance can be an effective tool when communicated clearly, and that asset-purchase programs such as those conducted by the Federal Reserve and European Central Bank have successfully “affected yields,” Wilkins said.
Asked after the speech about the limits of quantitative easing, Wilkins said those limits are still being tested in places like Europe.
“I don’t think anybody knows what it is now,” Wilkins, speaking at the University of Toronto’s Rotman School of Management, said in response to a question from the audience.
Central bankers are also grappling with issues of financial system risk that weren’t front of mind before the crisis, Wilkins said, adding the central bank is trying to do a better job of modeling these risks in its analysis.
The inflation targeting mandate itself was an innovation and initially resisted when first considered in the 1980s, Wilkins said.
While the Bank of Canada remains committed to inflation targeting -- and the bar to changing the 2 percent target is high -- policy makers are “also committed to exploring how best to contribute to the Canadian economy in a world that is going through fundamental structural change,” Wilkins said.
“Even though the Bank has had the same mandate for 80 years, we haven’t been afraid to change our paradigm when circumstances demanded it,” Wilkins said.