Monetary Policy and Economic Stimulus

News this morning is that the Bank of Canada is signaling its intention to keep the overnight rate at .25% or effectively zero. Thus Canada will hold at the limit of traditional monetary policy. Given our current situation, this is probably the wisest course.

A widely circulated paper by Ken Rogoff and Carmen Reinhart of the U.S. National Bureau of Economic Research, "The Aftermath of Financial Crises", lists the types of problems that are likely to persist when events such as last year occur, and except for the level of debt, Canada is by every measure past this crisis.

Moreover, one of the lessons learned from the crisis, according to Joseph Gagnon of the Peterson Institute in the U.S. is that efficacy need not end at the zero bound. Indeed we know now that efforts at quantitative easing and other forms of non-traditional monetary policy played a significant role in attenuating the crisis.

The Gagnon paper is particularly interesting as it lays out a framework for effective counter-cyclical policy that avoids public debt. While there are inflationary risks here too, as the author recognizes, they are minimized by a type of policy that can be adjusted, up or down, much more quickly than fiscal measures that require legislative approval and once enacted quickly gather powerful constituencies.

This strength of monetary policy, however, might be seen as a source of weakness. It is the purview of central banks that operate at least at arms length if not independent from legislatures and executives. So while it can quickly be adjusted by administrative fiat it is often wholly unaccountable to those it serves.

So pick your poison.