Monetary policy is vital, but it cannot be the only way to fix the Canadian economy — it’s merely the first line of defence against inflation.
The Canadian and American economies are deeply intertwined. With the United States Federal Reserve cautious amid mixed signals from the labour market and rising inflation worries, the Bank of Canada has just lowered its key interest rate to 3.75 per cent — cutting it by half a percentage point.
Monetary conditions are transmitted from the world’s biggest financial centres to the rest of the world through gross credit flows and leverage. Any policy differences between Canada and the U.S. immediately impact Canada, including spillover effects on the loonie exchange rates and other widespread economical and social effects.
Canada, in contrast, has opted for free capital mobility and independent monetary policy at the expense of exchange rate stability. This allows the loonie to be determined by market forces, giving the central bank the ability to adjust interest rates while capital moves freely across the border. If the central banks were to remain at odds in the longer term, a decrease in money supply as investors flee would likely cause a decrease in domestic bank lending, which is already under pressure from public and private debt and increased default rates.
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