Bank of Canada governor Stephen S. Poloz spoke to the Association des économistes québécois, the Cercle finance du Québec, and CFA Québec on Tuesday about the reality of living with low interest rates. The speech, “Living with Lower for Longer,” highlighted some of the causes of the current rate environment, as well as steps that need to be taken in order for individuals and business to thrive as low rates remain.
Low rates have been pervasive for almost a decade, since the financial crisis sent the global economy into a tailspin. Although economies have improved, low rates remain, Poloz said, "mainly because the economic headwinds that the crisis created have been slow to fade."
Poloz acknowledged that this low interest rate environment may be great for people who have gotten a mortgage in recent years, but it’s not great for anyone who is trying to squirrel money away for the future, since the theory behind using low interest rates to stimulate the economy is that if there’s no benefit to saving money, then people will be more likely to spend it/loan it and pump it back into the economy. The problem is that this free spending isn’t always possible for everyone, such as retirees, who need to live off of their savings, not to mention that in times of economic uncertainty, people tend to hold onto their money for fear of losing their sources of income. But Poloz also pointed out that the value of most assets rise when interest rates are low – namely real estate – and stock and bond prices are higher, which are also significant sources of wealth for many Canadians.
Although the BoC indicated that the economy should return to full swing by 2017 in their last Monetary and Policy report, “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. “We also need to watch the full effects of the government’s fiscal stimulus unfold.”
He mentioned other factors behind the sluggish economy, such as a growing number of retirees who have exited the workforce, triggering a general slowdown in labour, and a decrease in global spending because of less potential for economic growth. In fact, Poloz said that one of the main causes for weak investment is uncertainty when it comes to future demand.
“When investment slows, it means an economy’s potential output also grows more slowly, which can reinforce the trend toward lower interest rates. In contrast, raising potential output through increased investment can ease the downward pressure on global rates.”
In his speech, Poloz did say that Canada needs to be more accommodating to new businesses in terms of taxes, immigration policies, and financing, in order for them to grow and benefit the economy. He also said that infrastructure projects provide both short- and long-term boosts to the economy, and that trade liberalization is key, both international as well as inter-provincial.
"At the heart of this discussion is the level of the real rate of interest. Having higher nominal interest rates because of higher inflation would not help savers, because higher inflation would just erode the future purchasing power of those savings. Maintaining a low-inflation environment is the Bank’s primary goal. We do this because we’ve seen that it is the best way to help bring about solid, sustainable economic growth. That growth benefits everyone, from business owners looking to expand, to workers looking for employment, to savers looking to protect their savings and find investment opportunities."
And so where does that leave homeowners when it comes to the months and years ahead?
Low interest rates have been blamed for the spike in home prices in some housing markets, but there is a chance that this prolonged state may now actually reduce some of the demand on housing markets. Since interest rates are projected to remain low for the near future, perhaps more homebuyers won’t feel as much pressure to get into the market and secure a mortgage before interest rates rise. And if homebuyers don’t feel the urgency to jump on any available home that comes on the market, then maybe homebuyers will be the ones who start a cooling process in those same housing markets that they heated.
We’ll have to wait and see. In the meantime, Poloz reminded the economists that “ultra-low” interest rates are a symptom of the current economic climate, and that the BoC does believe that the climate is improving, albeit slowly.
“But some of the forces leading to low interest rates will persist for a long time, so we need to prepare for lower for longer,” Poloz said. “Individuals need to plan for retirement with different assumptions about longevity, interest rates and growth. Businesses need to make sure their expectations about investment returns reflect the current and likely future reality and reconfigure their investment plans accordingly. And 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.”
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