The Unintended Consequences of Central Bank-Induced Low Interest Rates

Research Paper on the widespread economic distortions and negative outcomes resulting from the Bank of Canada’s sustained low interest rate policy

While lowering interest rates has a short-term stimulative effect, maintaining low rates over a longer period of time may have the opposite effect, of inhibiting growth and productivity improvements, according to a Montreal Economic Institute researcher.

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This Research Paper was prepared by Jerome Gessaroli, professor at the British Columbia Institute of Technology’s School of Business, and Senior Fellow at the MEI.

INTRODUCTION

Since 1991, the Bank of Canada, in agreement with the federal government, has set its monetary policy to keep annual inflation at 2%, the midpoint of its 1% – 3% target range.(1) This target is believed to be consistent with maximum economic growth and stable prices.(2) The Bank has a range of policy tools to influence growth and prices, and the authority to use them.(3) In response to economic problems—ranging from slow economic growth to financial crises—the central bank has acted over time to loosen monetary policy.(4) By pushing interest rates lower, central bank governors seek to encourage economic growth, and by raising rates, to limit inflationary pressures.(5)

Yet while almost all will agree that monetary policy does indeed exert a potent influence on the economy, that same potency leads to widespread economic distortions and negative outcomes that unfortunately affect some parts of society more than others. What has made the recent past unique is the central bank’s actions to maintain continuously low interest rates over extended periods of time.

This paper’s purpose is to review the impacts of the Bank of Canada’s induced continuous low interest rate policy on the Canadian economy. It will specifically highlight the policy’s unintended consequences, estimate their severity, identify those groups most affected, and highlight the policy’s economic distortions. The paper also recommends a variety of policy actions that both the central bank and federal government can undertake which will help alleviate those negative effects.

This paper does not question the need to use monetary policy in times of financial crisis or its short-term beneficial effects. The Bank of Canada needed to and did use its policy tools to lower interest rates and provide liquidity during the 2008 financial crisis and the 2020 COVID-19 related economic disruption. Rather, what has inflicted significant negative economic effects is the central bank’s asymmetrical actions in lowering rates in times of trouble but not raising them when the economy stabilizes and growth has returned. Persistently low interest rates have inhibited growth and employment, and have created asset bubbles in the real estate and equity markets that are both exacerbating economic inequality and undermining financial stability.

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