Bank of Canada Deputy Governor Timothy Lane just provided a bevy of reasons why the central bank likely will take a break from raising interest rates, including a stronger currency and uncertainty over whether the North American Free Trade Agreement will survive the reign of Donald Trump.
Why Lane’s speech it matters
Lane’s speech in Saskatoon on Sept. 18 was the first by a Bank of Canada leader since the central bank raised interest rates earlier this month. (Senior Deputy Governor Carolyn Wilkins spoke at an event in Ottawa last week, but steered clear of direct commentary on the economy.)
His remarks can’t be considered a roadmap for the future path of interest rates; he made a point of stating that every policy meeting is “live,” meaning the latest data could alter assumptions.
But unless Statistics Canada keeps publishing off-the-chart indicators like second-quarter gross domestic product, the Bank of Canada probably prefers to wait a bit and see what how its two summer interest-rate increases play out. Lane stressed the importance of trade to Canada’s economy, and prospects for trade are unknown as long as the Trump administration keeps threatening to quit NAFTA.
There’s lots of political talk these days about how trade is, well: Bad! (Especially deficits. Sad!)
Lane did a nice job of reminding his audience why trade is good. First, it allows companies in smallish countries such as Canada to expand their markets and get more out of their investments in labour and capital. Second, freer trade introduces competition, which boosts productivity and encourages companies to innovate. That’s how wealth is created. By way of example, Lane noted that Saskatchewan barely grew any pulses a few decades ago. Then, researchers started working on varieties of lentils and peas that would do well on the Canadian prairies. Now, Saskatchewan exports more lentils than it does wheat.
If Lane’s arguments in favour of trade sound new, it’s because politicians don’t like to talk about trade as a productivity booster. That’s because weak companies die and people lose their jobs when tested by stronger competition. Yet others thrive, and those companies eventually grow and more than make up for the jobs that disappear through a phase of creative destruction.
Some economists are dismissive of the losers from trade. The Bank of Canada, to its credit, has responded to the election of Trump by nudging governments in Canada to do more to help individuals compete in the modern economy—not just firms. (That’s a big step for the central bank, which would prefer to talk only about what it’s doing to control inflation.) Lane kept up that effort, saying that governments must put a greater emphasis on retraining and lifelong learning or risk a public backlash against the merits of freer trade.
Glass half full
If not for the NAFTA talks, the Bank of Canada would be feeling much better about the economy. Lane added some texture to the central bank’s decision to increase interest rates, saying policy makers were encouraged by “widespread strength” in exports and business investment. Lane also noted the jump in imports of machinery and equipment, a sign that companies are gearing up to meet increased demand.
Finally, Lane indicated that stronger global demand might actually allow the central bank to pause from raising interest rates. That’s because all those indicators of business investment could be adding to the economy’s ability to generate growth without stoking inflation. “That growth potential could be greater than we think — if businesses find new ways to engage with [global value chains] and develop new products and processes to make them more productive and competitive,” Lane said.
The new free-trade agreement with the European Union, which is about to take effect, also should help, he said.
Glass half empty
The global value chains that Lane referenced are important. Trade used to be about swapping the stuff that one country produced cheaply with the stuff that another country produced cheaply: Canada shipped wheat and imported oranges, to take a simple example.
Modern trade is more about intermediate goods than finished goods. The elimination of tariffs allows companies to dramatically lower their production costs by sourcing inputs from the most efficient factories, wherever they might be. That’s why the renegotiation of NAFTA is so troubling: higher tariffs would force countless North American companies to rethink their production chains. It’s hard to imagine the result, but it wouldn’t be good for Canada. A loss of market access likely would hurt Canada’s economic potential, which would weaken its ability to absorb faster economic growth without triggering inflation. Perversely, that would force the Bank of Canada to raise interest rates.
“The Bank of Canada is not, of course, at the negotiating table,” Lane said. “But the outcomes, when they materialize, could have important implications for the Canadian economy which we would need to consider in making monetary policy.”
The Bank of Canada couldn’t ignore an annual growth rate of 4.5 percent in the second quarter, which was much faster than expected: “That’s kind of what data dependent looks like,” Lane said, repeating Governor Stephen Poloz’s mantra that the newest information will guide policy. “We’re watching the numbers as they come along.”
Still, the central bank was reluctant to raise interest rates at the beginning of the year, and it remains so now. “Interest rates are still quite low,” Lane said. “That still seems appropriate, partly because we don’t know how the economy is going to react to what we’ve done so far.” The record level of household debt is a concern. But the near future of the country’s trading prospects might be the bigger worry. Lane talked of Canada’s need to restore its place in global supply chains after the Great Recession and how a stronger currency “battered” exporters after the financial crisis. That process is coming along, but remains unfinished. Lane said the exchange rate, which surged this summer, will be considered “pretty strongly” when policy makers next deliberate. The state of the NAFTA talks also will make its way into discussions. Given all the emphasis the central bank has put on trade, how could they not?