Tuesday, 17 September 2013

The Real Problem with Low Interest Rates


In a recent paper for the C. D. Howe Institute, economist Paul Masson argued that the Bank of Canada should commence allowing interest rates to rise to avoid greater real-estate bubbles and excessive debt. When Paul Masson argues that the Bank of Canada’s low interest rate policy destabilizes the economy through potential bubbles and debt buildups, he’s correct. (Indeed, I’ve made the same arguments many times, see here or here.) Unfortunately, this focus misses the broader problem with low interest rates.

The Bank of Canada is charged with the goal price stability. To this end it tinkers with the money supply in a bid to engineer that perfect amount of credit growth to keep inflation around that supposed sweet spot of 2 percent a year. (One would think “price stability” would be no inflation, but that’s another issue.)

Most people understand that there are some real problems with engineered prices. Any student of a first-year University economics class knows that prices are not generally set by any one person in the economy. They are the result of the interplay between the supply and demand for something.

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