The limits of cheap money

Something I think we can say we've learned from the economic events of the past half-dozen years: throwing cheap money around may prevent disaster, but it can't be relied on to stimulate growth.  That's not a new lesson, of course. Keynes famously identified the risks of a "liquidity trap", and economists have always warned that in the absence of underlying demand, expansionary monetary policy is akin to pushing on a string.  Still, there can be no doubt that the limits of monetary policy have never before been so uncomfortably clear.

You can see evidence of this all around the world, but for Exhibit A today, let's look at Canada, where central bank Governor Stephen Poloz has yet again left the benchmark interest rate at one percent, in the face of the economy's continuing failure to post strong growth. Like the US, Canada experienced an exceptionally severe winter this year, resulting in a slowdown in GDP growth in the first quarter.  There are high hopes that things will rebound in the current quarter, piggybacking on an expected bounceback in the US, where the slowdown in Q1 was even more pronounced than in Canada.  However, despite the supposed benefit of a weaker exchange rate, Canada's export sector has delivered nothing but disappointment in recent months.

Data released this week show that exports fell yet again in April.  It's starting to look as though Canada's international trade problems are not related to price competitiveness per se, but may instead be structural. Manufacturing may never recover the losses suffered over the past couple of decades, leaving hopes of export gains far too dependent on the energy sector, which is encountering increasingly severe problems in getting its product to foreign markets.  There's not a whole lot the Bank of Canada can do about that.

With the US Federal Reserve taking a very measured approach to removing its own monetary stimulus, there's no immediate pressure on the Bank of Canada to act.  But there are clouds on the horizon.  When Gov. Poloz took over the job less than a year ago, he mused aloud about deflationary risks.  No more: CPI has moved up to the Bank's 2% target, perhaps a little faster than the Bank had expected.  This is no surprise in light of the fall in the Canadian dollar, and as that decline seems now to have stopped, perhaps upward price pressure from this source will abate. Still, the Bank has a bit less breathing room than it might have hoped.

In addition, the Bank has to take account of the fact that household debts remain uncomfortably high in relation to disposable incomes. Much of that debt is housing-related, and the continued upward pressure on house prices in certain markets (most severely, but not exclusively, in Toronto) adds to the risk that some consumers will take on debts that they won't be able to service once rates do start to rise.  The banks seem to be chafing at the bit to offer deals to mortgage borrowers, and it may soon be necessary for Gov. Poloz or Finance Minister Oliver to rein them in again.

What it all comes down to, in Canada as in the rest of the developed world, is that flooding the system with cheap money was the easy part.  Pulling back that stimulus, without triggering another recession or even a further crisis, is something nobody seems to have figured out just yet.