Photo by Michelle Spollen on Unsplash
Central bankers are always conjuring up the perfect interest conditions in which everything is in balance. The elusive measure is referred to as “the neutral “rate of interest which allows the economy to expand without leading to inflation nor to decline in output. We are going to hear more about “R-star” in the future, as a measure of the (real) interest rate that keeps overall demand and supply in a comfortable balance. But R-star can neither be carefully articulated nor accurately measured. It is largely a figment of the imagination of economists. Nonetheless, central bank research departments are trying their best to get a handle on a measure that can then be plugged into their forecasting and how best to achieve that elusive balance. Research to date, argues that the R-star was about 2.2% at time of the 2008 financial crisis. It subsequently dropped to 0.8% and remained at that low level until this spring when it fully recovered to 2%. More to the point, the general consensus is that, despite a recovery, the R-star remains too low.
Today, central bankers are looking at an R-star that is lower than they would wish. Recent increases in the long bond rates, are taken as a sign that the economy can withstand a higher R-star. Be that it may, these estimates of R-star are all that we have to go by.
Governor Macklem, appearing before Canadian Senate committee, has now joined the musings about the neutral rate for Canada, stating “there are some reasons to believe it’s more likely that the neutral rate is higher than lower.”Without elaborating, he adds that higher fiscal deficits, an aging population and a shift towards renewables energy resources supports his claim. This is just pure supposition, since economists do not really understand what gives rise to a higher neutral rate. Putting the theory aside for the moment, the key takeaway from Macklem’s position is that he believes it is “more likely that the neutral rate is higher than lower,”. Put simply, the rates currently in place are more likely to be a floor than a ceiling. Or, worse yet, we are in for additional rate hikes, if the Bank deems that R-star is too low. At any rate, the Bank of Canada is using this concept to support their current position against any discussions of rate cuts.
Meanwhile back at the ranch, the Canadian economy is weakening. The Canadian dollar has been under steady downward pressure, residential and non-residential investment is declining and the forecast for GDP calls for continued stagnation . In this environment, the importance of getting a handle on the theory takes a back seat to the need to be ready to reverse course to manage an economy that clearly needs help.More By This Author:The Bank Of Canada’s Anti-Growth Policies Are Coming To FruitionCanadian Dollar Weakens As The Economy Slides Into Recession Businesses Are Warning The Bank Of Canada That Stagnation Is Just Beginning
