The Bank of Canada’s efforts to keep financial markets functioning through the COVID-19 crisis will lay a solid foundation for economic recovery. Deputy Governor Toni Gravelle explains how. He also discusses the decision yesterday to leave the policy rate unchanged.
Policy rate unchanged
We decided to leave the policy interest rate at 0.25 percent.
The Bank took swift action
When the COVID-19 pandemic hit, markets were gripped with uncertainty about how bad and how long the economic downturn might be.
When uncertainty ripples through markets, they stop functioning normally. That can halt the flow of credit that households and businesses depend on.
The Bank took swift and decisive action to ensure that markets keep working properly. This allowed households and businesses to get the credit they need to make it through the crisis.
Well-functioning markets will still be important once we move from crisis to recovery. This is because they will help pass our very low policy interest rate through to all corners of the economy.
We need to maintain a well-functioning financial system. That way, our policy actions get through to people and businesses.
Ensuring that credit can flow
The financial system works best when people, companies, governments and financial institutions such as banks have cash to operate on a daily basis—what’s known as liquidity.
In normal times, there is plenty of liquidity to go around.
But in a crisis, everyone wants cash, and few want to trade assets. They think it’s safer to just hold on to what they have and wait. This causes liquidity to dry up, making it harder for people, companies and governments to get the cash they need.
When the system can’t supply liquidity to those who need it and credit doesn’t flow, the effects of a big economic shock such as COVID-19 can be worse and the recovery can take longer.
The Bank used several different tools to improve:
- funding for banks, so they could continue lending to people and businesses
- liquidity and functioning in a range of core markets, by purchasing financial assets such as bonds in exchange for cash
Because the problem affected the whole system, the Bank of Canada responded swiftly with a broad suite of programs.
Markets are returning to normal
Because our actions involved increasing liquidity by buying financial assets, the Bank’s balance sheet has expanded. This is not new for central banks. In fact, it’s one of our original functions—to be the lender of last resort, providing liquidity across the economy.
Many key markets that had been showing significant stress now appear to be working better:
- Market liquidity has improved, and banks have much better access to funding.
- Many of our programs are being used less and less as conditions in markets stabilize.
These are early results, but they are encouraging.
Our decision yesterday
Given those positive signs, we said yesterday that we’re scaling back some of our market programs. Others—such as large-scale purchases of federal and provincial debt—will continue as they were.
We also see signs that the impact on economic activity from measures to contain COVID-19 has peaked.
Government support measures are replacing income lost by many workers who were laid off or had their hours cut, and surveys show many people who have lost their job expect to return to it.
Still, many risks and uncertainties remain. A lot hinges on how quickly measures to contain the coronavirus are lifted, and how well Canada and other countries can deal with any future waves.
The stance of the Bank’s monetary policy will depend a lot on what happens to the balance between what the economy can supply and what people demand, because this will affect the outlook for inflation.