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Sub-zero policy rate an option in unlikely event of future crises, Poloz says

OTTAWA – For the first time, the Bank of Canada says it would consider nudging its trend-setting interest rate below zero if the country ever absorbed a severe economic blow like the 2008 financial crisis.

In a speech Tuesday, governor Stephen Poloz announced an updated framework of unconventional instruments the bank could wield to deal with the unlikely event of another shock.

Among the new possibilities: a negative key interest rate.

Central banks around the world have turned to unconventional monetary policy, including below-zero benchmarks.

For example, Poloz noted that the European Central Bank and Swiss National Bank adopted negative rates after the crisis. Financial markets, he added, were able to adjust and continue with their operations in that new environment.

The Bank of Canada has learned from experiences like these abroad and is confident Canadian markets could also handle a sub-zero situation.

The announcement comes at a time when the Canadian economy has struggled to re-emerge following the steep slide in commodity prices.

But Poloz stressed that the fact he listed new unconventional monetary measures Tuesday should in no way be taken as a sign the bank is about to use any of them. He reiterated his confidence that recovery is well underway in Canada.

Still, the list of potential unconventional options needed an update, he said.

“We’re making sure that our tool kit is up to date,” Poloz said in Toronto, where he addressed the Empire Club of Canada.

“We see no reason to be contemplating these measures.”

The Bank of Canada first produced a framework of unconventional measures in 2009, which featured options such as forward guidance and large-scale asset purchases, also known as quantitative easing.

In 2009, the bank used a form of forward guidance, which gives a heads up to markets on interest-rate movements, when it committed to keep the key rate unchanged for a year as long as there was no change in the inflation outlook.

On Tuesday, Poloz announced another new unconventional measure added to the arsenal: funding for credit.

The tool would ensure economically important sectors had continued access to funding even when the credit supply was impaired, he said.

But the negative-interest-rate option will likely attract the most scrutiny — because it begs the question: why would anyone accept a negative return when they could keep it as cash?

Negative rates can still be attractive to investors because there are costs associated with withdrawing, moving, storing, insuring and securing actual money, especially in large quantities, said CIBC chief economist Avery Shenfeld.

Shenfeld said such a move wouldn’t mean much for the average person on the street because it would be unlikely to put retail-deposit and mortgage rates into the negative.

Poloz also announced Tuesday that the Bank of Canada lowered the “effective lower bound” — or the floor — for its benchmark rate into sub-zero territory for the first time. That floor dropped to negative 0.5 per cent from the positive 0.25-per-cent mark set in 2009.

The bank’s rate hit that 0.25-per-cent level in 2009. Today, the key overnight rate sits at 0.5 per cent.

“While we now believe that interest rates can be pushed below zero, there still is a lower bound,” Poloz said.

“So, we can’t be cavalier about how much room to manoeuvre we have. Further, there is evidence that consumers and businesses respond less to interest-rate declines when interest rates are already very low.”

Even though he presented the new options, Poloz noted that in extreme crises increasing fiscal stimulus tends to be a more powerful approach than adjusting monetary policy.

Poloz also reiterated his optimism for the Canadian economy and reaffirmed his projection it was strengthening underneath the more-apparent pain of persistently low resource prices. The non-resource sectors, Poloz added, have continued to improve.

“Given this outlook, it may seem like an odd time to be updating our unconventional monetary policy tool kit,” he said.

“I certainly hope that we won’t ever have to use these tools. But in an uncertain world, a central bank has to be prepared for all eventualities. In short, should the need arise, we will be ready.”

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