OTTAWA — Canada’s response to the COVID-19 pandemic will “clearly lead to higher indebtedness” once the economic shock has passed, Bank of Canada governor Stephen Poloz warned Monday.
Poloz pointed to a drop in interest rates that would normally boost near-term economic growth through greater borrowing — but such borrowing will add to debt levels the central bank has previously warned about.
That can lead to slower economic growth and make it more difficult for the central bank to hit its two-per-cent inflation target in the future.
And it can also increase the risk that a future negative shock will have a magnified effect on the economy, Poloz says.
He says the bank is developing new tools to evaluate this trade-off between faster growth today and slower growth down the road.
Poloz made the comments as part of a speech looking back on his time as Canada’s top central banker, which officially comes to an end next week, and look ahead at the economic climate his successor, Tiff Macklem, will face.
“Some of the financial vulnerabilities already present in the economy will have grown worse, and other sources of vulnerability are likely to emerge,” Poloz said in the speech, the text of which was released by the bank Monday afternoon.
“We are truly entering unknowable times.”
It wasn’t long after Poloz first took over from Mark Carney, who had Macklem as his second-in-command, that the bank’s key interest rate in 2015 dropped to 0.5 per cent in response to an oil price shock.
The rate started to rise again two years later, eventually hitting 1.75 per cent.
Then the pandemic struck Canada hard in March, compounding declining oil prices.
Over the course of the month, the central bank cut its policy interest rate to 0.25 per cent — the lowest Poloz says it can go — and began an unprecedented purchasing spree to help ease constraints in financial markets and allow governments to fund massive support programs.
Poloz says the dominant concern at the bank was the risk that deflation could emerge without such aggressive actions, then combine with existing debt to fuel an economic depression.
“The downside risks were sufficiently dire that there were no relevant trade-offs for monetary policy-makers to consider,” the text of his speech reads.
“Picture the pandemic creating a giant deflationary crater in the middle of the economy; it takes what looks like inflationary policies to offset it.”
Things seem to be working well, he says.
Poloz says the central bank will have to provide “significant monetary stimulus” as the economy begins to rebuild, although it’s unclear how much and for how long.
“The actions taken to counter the effects of the pandemic will clearly lead to higher indebtedness, for governments in particular,” he says.
“Getting the economy back onto its growth track — which is what is required if we are to hit our inflation target — is the surest means of servicing those debts over time.”