Poloz Touts Trade and Infrastructure as Low-Growth Antidotes

  • Bank of Canada Governor says profound, gradual forces at play
  • Downturn in one housing market is rarely ‘contagious’

Bank of Canada Governor Stephen Poloz urged the country’s policy makers to press ahead with efforts to remove trade restrictions and spend more on infrastructure in order to boost sluggish long-term growth.

Poloz, speaking in Quebec City, said an aging population and other factors have pushed down the country’s “potential” growth rate to about 1.5 percent, adding to downward pressure on interest rates that go well beyond efforts by central banks to stimulate the economy.

“Policy rates have generally remained extremely low, mainly because the economic headwinds that the crisis created have been slow to fade,” Poloz said. “This is about much more than monetary policy. There are big, long-term, global forces acting on interest rates, and people need to understand them better.”

Tuesday’s speech is in line with recent communications by the Bank of Canada that low growth rates are due to fundamental factors and require a broader policy response than just monetary policy to counter. The economy is facing strong headwinds, and continues to need stimulative monetary policy to counteract them, but at the same time, the central bank must wait to gauge the full effect of the government’s fiscal measures, Poloz said.

Cuts Unlikely

“Rate hikes are clearly not on the horizon,” said Krishen Rangasamy, senior economist at National Bank Financial in Montreal. “And when they do come, rate normalization will end up a relatively low level thanks to the lower neutral rate.”

The odds of a cut at the Oct. 19 meeting fell to 8.5 percent after the speech, from about 10 percent the day before, according to Bloomberg calculations on overnight index swaps.

Asked at a press conference about the risk of a housing slowdown in Vancouver leading to a broader economic deterioration, Poloz said weakness in one housing market is rarely “contagious.”

Some of the price gains in Vancouver, and to a lesser degree Toronto, are hard to explain based on economic conditions, though strength in the economies and labor markets of both cities will play a large role in how conditions evolve, Poloz said.

Deeper Examination

At its Sept. 7 rate decision, the central bank said the risks to its inflation profile had tilted to the downside, suggesting exports had been unaccountably weak. Poloz elaborated on that Tuesday in the press conference, saying the total dollar value of exports had disappointed, even after recent gains in the growth rate of non-commodity shipments.

The central bank is engaged in a deeper examination of exports and U.S. and Canadian business investment, and it remains unclear if forecasts will be cut at the Oct. 19 meeting, Poloz said.

While uncertainty seems to be the major cause for low business investment, “I have picked up on another possible investment impediment -- hurdle rates for new investments do not seem to have adjusted to the new reality,” Poloz said, referring to the lowest acceptable rate of return a company needs before it will invest.

Business Investment

“Businesses need to make sure their expectations about investment returns reflect the current and likely future reality and reconfigure their investment plans accordingly,” Poloz said, adding that 4 percent will probably turn out to be a pretty good return.

A low growth and interest rate environment makes growth-enhancing measures by governments even more critical, including infrastructure investments that will improve productivity.

“In a lower-for-longer world, these are opportunities we simply cannot afford to miss,” Poloz said. “Policy-makers need to make sure they are working to increase the economy’s potential output and reduce uncertainty -- whether economic, political or regulatory -- that may be holding back investment.”

To be sure, the economy is still in a period when monetary policy needs to be stimulative, he said, reiterating the Bank of Canada’s assessment earlier this month that inflation risks had shifted.

Strong Headwinds

“It is quite evident that our economy is still facing strong headwinds, and we need stimulative monetary policy to counteract them and move us closer to full capacity,” Poloz said. “Low interest rates are actually having big effects today, but the headwinds pushing back on that stimulus remain quite powerful.”

Still, the potency of monetary policy has weakened as the potential growth has fallen, Poloz said.

Low growth, meanwhile, is here to stay even with the central bank providing stimulus, said Poloz. The country will continue to be in an era of low rates even after stimulus is eventually withdrawn, he said.

“The decline in the real neutral rate means that any given setting of our policy rate will be less stimulative today than it was a decade or two ago.”

The Bank of Canada estimates Canada’s neutral nominal interest rate -- the borrowing cost that is neither stimulative or contractionary when the economy is operating at full capacity -- is between 2.75 percent to 3.75 percent. That’s down from a range of 4.5 percent to 5.5 percent before the crisis.

In his speech Poloz estimated the potential benefits of a number of reforms. The removal of interprovincial trade barriers could add as much as 0.2 percentage points to growth, while the Trans-Pacific Partnership trade deal could add about the same amount. Fulfilling trade deals and pressing ahead with targeted infrastructure spending could drive GDP up by as much as 5 percent by 2025, or C$100 billion in income each year, Poloz said.

In the meantime, his policy recommendation for savers is “to plan for retirement with different assumptions about longevity, interest rates and growth.”

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