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Years of Near-Zero Interest Rates the Latest Bid to Spur Recovery in US, Canada

The Canadian and American central banks are pulling out all the stops to support the economic recovery, with the latest move being their indications that they expect to hold interest rates near zero over the next few years. However, as the COVID-19 pandemic persists, the hoped-for sustained revival in consumer borrowing and spending is anything but certain.

In an unprecedented move on Sept. 16, the U.S. Federal Reserve said it doesnt expect to raise its key interest rate until 2023, providing a very powerful signal that near-zero rates are here to stay for a long time.

A week earlier, the Bank of Canada had said, “The Governing Council will hold the policy interest rate at the effective lower bound [0.25 percent] until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved.”

In Canada, the annual rate of inflation has been stuck at just 0.1 percent for the past two months. The 2 percent target is an international standard to keep price increases under control while promoting the economic and financial well-being of citizens.

Ever since the financial crisis, interest rates have been very low by historical standards, but there was always that element of uncertainty about when rates might go up. And they eventually did in the United States and Canada.

But now the U.S. and Canadian central banks have laid out their game plans very clearly to remove uncertainty and incentivize consumers and businesses to spend and invest—and take on risk. Its an extreme use of one of the tools of their monetary policy—forward guidance.

Borrowing Less Appealing, Spending Impacted

Benjamin Tal, deputy chief economist at CIBC, told The Epoch Times that he doesnt see a big pickup in consumer spending, as this really needs higher-income households to play their part. What has happened during the pandemic is that the rate of savings has gone up since incomes have been supported on the whole, but spending has fallen.

Lower-income households tend to spend that extra dollar but also have fewer dollars to spend, as lower-paying jobs like in retail and hospitality have been more impacted by the pandemic.

As for the housing market, an important contributor to consumer spending thats been a big winner benefiting from near-zero interest rates, its soared from pent-up demand. However, Tal doesnt see a return to the extended red-hot housing markets and talk of bubbles bursting from a few years back, as unemployment is still much higher than pre-COVID and the economy is still in the grips of the pandemic.

Tal notes that while mortgage debt is growing, debt from consumer loans and credit cards is diminishing.

“I suggest that the credit accumulation will not recover in a very significant way over the next six months, because the [pandemic] fear factor will be dominating again,” he said.

If consumer spending and business investment were to pick up, as policy-makers hope, this would lead to more jobs being created.

“Lower borrowing costs stimulate economic activity, which in turn boosts jobs and incomes, particularly for people with lower incomes,” said Bank of Canada governor Tiff Macklem in a Sept. 10 speech to the Canadian Chamber of Commerce in Ottawa.

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Poorer people generally rent and arent always able to borrow and buy houses, so its less clear how providing ultra-cheap credit is helping this segment of the population with spending on housing, says Nipissing University emeritus professor of economics Christopher A. Sarlo.

“I think its going to have more effect on the middle class,” he told The Epoch Times. “Ongoing full-time work is the surest escape from poverty.”

Meanwhile, those who rely on an investment return from bonds are seeing their incomes shrivel and may be pushed into the stock market, taking on additional risk at a time in their lives when it would not typically be advisable.

“With any return on fixed income, which is basically approaching zero, more and more money is chasing risk assets, like the stock market, creating the risk. So this is not a healthy situation,” Tal said.

New Approach to Inflation

Central banks want to make sure inflation expectations—an important driver of the actual inflation rate—dont undershoot the 2 percent target, which would complicate the recovery process, University of Waterloo economics professor Jean-Paul Lam told The Epoch Times.

Falling inflation expectations lead to people delaying purchases and businesses delaying capital spending, since they think it will be cheaper to do so in the near future. And if this goes on for some length of time, the eRead More – Source

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