2014-14 A word from a WLU econ graduate

The new Senior Deputy Governor of the Bank of Canada, Carolyn Wilkins, BA '87, delivered her first policy speech. She said that the "neutral interest rate" has fallen from 4.5% to 5.5% in 2000s to 3%-4%

What is the neutral interest rate? In her own words, “The neutral rate is to economists what dark matter is to physicists. We are convinced it exists, it plays a central role in our models and analysis, but we can¹t directly observe it.”

Well, actually we do not know the value. What she calls the "neutral" interest rate is the rate which the Bank of Canada should maintain when the economy is operating at capacity (i.e. when output equal potential output, or the unemployment rate equals the natural unemployment rate). With such rate at full employment, inflation will be stable.

She also mentioned that the Bank of Canada does not know when the economy will return to full employment.

Two morals of that story:
1. The effects of the Great Recession will linger for quite some time
2. The Bank of Canada does not know what interest rate it should set or when. That makes the task of monetary policy difficult, wouldn't you say?

By the way, the Globe and Mail article is more detailed, but gremlins struck again. At the beginning of the article they write: " "3 to 4 per cent,” roughly 1.5 percentage points below its historical norm", at the end they write  " the historical norm of about 4 per cent". Go figure.