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Why Carney should have cut interest rates

Bank of Canada Governor Mark Carney walks to a news conference in this 2009 photo.

BLAIR GABLE/REUTERS

As expected, the Bank of Canada left its target for the overnight rate at 1 per cent, as well as leaving the Bank Rate and the deposit rate unchanged. Although it was the expected move, it may not have been the correct one.

The monetary policy actions taken by any central bank should be judged by how well those actions fit into that bank's mandate. The Bank of Canada has a very straight-forward mandate: keep the target for the overnight rate between "1 to 3 per cent, with the Bank's monetary policy aimed at keeping inflation at the 2 per cent target midpoint."

If the Bank is going to miss hitting 2 percent, it should slightly err on the side of slightly above 2 per cent inflation during slow economic times, and slightly below 2 per cent inflation during booms. This gives us tool which to judge the Bank of Canada's actions: Is inflation expected to be at or slightly above 2 per cent for the foreseeable future?

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The bank believes that core inflation will stay around the 2 per cent level, and that total CPI inflation will "remain noticeably below the 2 per cent target over the coming year before returning to target around mid-2013."

This is in line with private sector forecasts. A June 27 TD Economics forecast predicts that the CPI will hover between 1.3-1.7 per cent in 2012, while core CPI will be in the 1.6-2.1 per cent range. Scotiabank has a somewhat higher estimate, with both total and core CPI hovering around the 2 per cent mark. Taking all of these forecasts into account, I expect core inflation at approximately 1.9 per cent and total inflation closer to 1.6 per cent.

I would have liked to have seen a rate cut, as a small rise in total CPI inflation and core inflation would bring the bank closer to its mandate. However, given that both forecasts are slightly under 2 per cent, the Bank's actions are justifiable.

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About the Author

Mike Moffatt is an Assistant Professor in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business – Western University. Mike also does private sector consulting for the chemical industry. More

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