Bank of Canada Deputy Says Policy Must Consider Debt Risks

(Bloomberg) -- Bank of Canada Deputy Governor Paul Beaudry said policy makers need to consider the potential long-term costs of rising debt levels when making decisions such as lowering interest rates.

In a lecture at Laval University in Quebec City, Beaudry said financial vulnerabilities are tricky for central bankers, because they create intertemporal trade-offs. That means short-term gains from lower rates may be offset by weaker growth in the future due to increased vulnerabilities.

Ultimately, that means policy makers may need to sometimes introduce a degree of flexibility in the inflation targeting process, taking longer to achieve it in order to prevent a pick-up in debt.

“If we bring financial vulnerabilities into the equation, it means introducing a degree of flexibility into the inflation-targeting process,” Beaudry said, according to a text of the lecture provided to reporters in Ottawa. “Financial vulnerabilities may make it harder to achieve our inflation target in the future.”

The comments, while technical and somewhat academic in nature, come a week after the Bank of Canada held off from lowering interest rates, citing worries about inflating already elevated household debt levels.

While Beaudry didn’t reference last week’s meeting, he did use the October rate decision as an example of the trade-offs that policy makers are forced to make in the face of financial vulnerabilities.

“Given the state of the financial vulnerabilities in Canada, we judged the risk of reigniting an acceleration in house price expectations and a buildup of debt was too high -- and that could make attaining our inflation target harder in the long run,” said Beaudry, who oversees the central bank’s Financial Stability Department.

Other Highlights

• Beaudry says there are two reasons why financial vulnerabilities create challenges:
  • They create intertemporal trade offs
  • They evolve more slowly and impact harder to predict
• Financial vulnerabilities, such as household debt, have the potential to accumulate sufficiently during booms and eventually reverse the initial positive impact of lower interest rates
• The challenge is that the same policy choice that helps the central bank attain its inflation target in the short run may be making it more difficult to attain its target in the longer run
• Inflation-targeting central banks should recognize this potential intertemporal trade-off
• Macroprudential regulations have helped mitigate financial vulnerabilities, but they don’t solve them all
• Regulations don’t mean monetary policy need not worry about financial vulnerabilities.

To contact the reporter on this story: Shelly Hagan in New York at shagan9@bloomberg.net

To contact the editors responsible for this story: Theophilos Argitis at targitis@bloomberg.net, Stephen Wicary

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