Saturday, January 17, 2009

Will the BoC cut to zero on Tuesday?

Perhaps. It would be a bold move, but perhaps not bold enough. I would still like to see the Bank attack credit spreads directly by purchasing commercial paper assets.

For what it's worth, my forecast
of GDP and core inflation suggests that a zero target for two quarters is the right policy under a conventional Taylor Rule.

The above path for the overnight rate assumes a significant output gap (>5% in Q12009) and core inflation close to 1%. Alternatively, if deflation is going to a problem, the BoC should go to zero on Tuesday and start thinking very creatively about how to engineer non-negative inflation expectations.

4 comments:

Nick Rowe said...

For what it's worth (which isn't much) I think it ought to go to zero (well, 0.25, which puts interest on reserves at zero) on Tuesday. But I don't think it will, since the Bank does not like to make big moves which surprise markets. The market is expecting a 50bp cut. My guess is that it might cut by 75bp.

Shock Minus Control said...

I think I might like to see them leave a little room for further action. I also think you're right that it will be at most a 75bps cut.

Nick Rowe said...

I really disagree with your "..leave a little room for further action" argument (if I interpret it correctly as "save some ammunition for later, in case it's needed". I would argue just the opposite: you need to fire more ammunition than you think you need, because the longer you wait, the more ammunition you need. I argued this on a post entitled "shooting bears" a month or two back at Worthwhile Canadian Initiative.

Shock Minus Control said...

It may be that I don't like the signal that cutting to zero in one shot sends to markets. It seems to say, "things are really bad and we at the bank are behind the curve".

However, if deflation is really going to rear its awful head, then I think you're right, we need to throw the kitchen sink at it. But we'll need more than just ZIRP and I feel like I haven't heard enough from the Bank about what that is.