With inflationary conditions relatively under control, it would be prudent to spur short-term growth prospects with cheaper borrowing.Mark Blinch/Reuters
Kevin Yin is a contributing columnist for The Globe and Mail and an economics doctoral student at the University of California, Berkeley.
This week’s inflation numbers were encouraging. But that’s not the only reason the Bank of Canada should cut interest rates at the next decision date in two weeks.
The 2024 federal budget announced last month includes a handful of tax increases to offset new spending, coming in just below the deficit level promised in the fall economic statement. New investment taxes will slow growth, while fiscal restraint will prevent demand-side surprises, giving the Bank of Canada both the incentive and the breathing room for expansionary policy. It’s all the more reason central bankers should plan a June rate cut.
The new taxes restrict both growth and inflation. Lowering interest rates does the opposite. With inflationary conditions relatively under control, it would be prudent to spur short-term growth prospects with cheaper borrowing.
Of course, the Bank of Canada cannot and should not attempt to make up for defects in long-term growth policy. But in the short term, less capital flowing through the market will hurt GDP, employment and people’s incomes in a way that can be corrected by monetary policy, particularly in the startup sector. Markets were already struggling before the tax hikes, with GDP per capita a shocking 7 per cent below trend and annualized business insolvencies more than 50-per-cent higher than they were last year. Monetary loosening will help offset these outcomes.
Even without new taxes, other developments in the economy were suggesting that a rate cut would be helpful without also being harmful. The Bank of Canada’s preferred measures of inflation – growth in CPI-median and CPI-trim – both fell in April to 2.6 per cent and 2.9 per cent respectively. The bank reports that the economy has excess supply capacity and that per capita consumption has been declining for the past five quarters. While Canada did add many jobs in April, the unemployment rate held steady at 6.1 per cent.
The most persistent component of price increases has been housing costs. But holding back on rate cuts won’t necessarily protect us here and could even make things worse. Higher interest rates can raise rents, as people move away from home ownership. While lower home values mean mortgage principals will be down, higher rates on those principals dull or even reverse the lowering of mortgage payments.
In this environment, one of the last conditions for lowering rates was fiscal co-operation from the federal government, which was not easy given the Liberals’ penchant for spending. Central bankers are always worried that their monetary goals will be thrown off by aggregate demand shocks from a government they can’t control. Government spending puts cash in people’s hands to buy more goods, generating upward pressure on prices, while taxes take it away. This is why deficits matter for inflation.
Luckily for us, Finance Minister Chrystia Freeland kept her promise. Taxes are going to increase enough to bring the projected net deficit to $39.8-billion, just under the $40.1-billion promised in the fall economic statement. It’s not frugality by any stretch of the imagination, but it didn’t have to be. For all the flaws of the 2024 budget, this signals that the government at least knows when to get out of the central bank’s way.
Bank of Canada Governor Tiff Macklem has hinted that he is sympathetic to this read of the situation. “The net effect of more spending and more revenue is that the fiscal track has not changed significantly since the fall economic statement,” he said in a statement in February, noting that the respect for fiscal guardrails was “helpful.” Mr. Macklem has not committed to cutting rates in June, the signature caution of a central banker. But now that core CPI measures have more or less stabilized, the bank should accept this as an assist from the government and ease the borrowing burden.
Aside from businesses, middle-class and low-income Canadians could also use a rate cut, especially through what has been an extremely painful affordability crisis. Canada has been fortunate to avoid a recession over this period of high rates, but this technicality is of little comfort to those still struggling to find work, meet mortgage payments and borrow money for their small businesses.
The Bank of Canada expects the median mortgage holder to be paying 34 per cent more per month by 2027, partly owing to higher rates. High interest rates punish borrowers, who tend to lack cash, and reward savers, who tend to have it, and also cut into companies’ ability to hire and retain workers. Thus low-income Canadians have been hit particularly hard, being the only income group to see their disposable income decline year after year as a result of interest-rate hikes.
With a weak economic outlook and sound fiscal conditions, both exacerbated and made possible by the new taxes, we should hope a rate cut is imminent.