Economy

Bank of Canada’s Neutral Rate of Interest Under Review

Bank of Canada’s Governor, Tiff Macklem, has raised concerns regarding the decision to maintain the neutral interest rate during the bank’s annual review. In remarks made at a Senate economy committee meeting on Wednesday, Macklem suggested that a gradual increase in this theoretical borrowing cost level—which is designed to neither promote nor hinder economic growth—may be warranted.

Macklem highlighted that any potential rise should be carefully assessed in light of growing fiscal deficits, an aging population, and increased investments in renewable energy. He expressed unease about the decision to keep Canada’s nominal neutral rate estimate stable between 2% and 3% following the annual review in April.

The Bank of Canada may interpret the current interest rates, which stand at a record high of 5% for the first time in 22 years, as being less restrictive than previously thought. This viewpoint aligns with earlier observations made by former deputy governor Paul Beaudry.

Macklem cautioned that escalating the neutral rate could lead to an overestimation of the tightness of monetary policy, potentially resulting in unexpected inflation and a necessity to raise interest rates to meet inflation targets. His remarks suggest a possible change in the Bank’s monetary policy stance, which could have considerable implications for the Canadian economy.

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