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How Far? How Fast? Getting Back to “Normal” Interest Rates: C.D. Howe Institute

May 29, 2013

TORONTO, May 29, 2013 /CNW/ – How far and how fast Canada’s record-low
interest rates will rise in the coming years is a vital question for
consumers and businesses. In “The New “Normal” for Interest Rates in
Canada: The Implications of Long-Term Shifts in Global Saving and
Investment,” authors Paul Beaudry and Philippe Bergevin find that the
normal or “neutral” rate is likely lower than its historical average,
and likely will remain at relatively lower levels over the next decade.

By any standard, interest rates in Canada and most other developed
countries are very low, note the authors. Inevitably, interest rates
will go up, and eventually return to more normal levels. In practice,
however, there is disagreement about when, and by how much, rates
should rise.

The authors provide guidance on where the Bank of Canada’s target
interest rate should stand once the Canadian economy is back to normal,
and growing in line with its productive potential.

Historically, the Bank of Canada’s target rate averaged about 3.8
percent from the end of 1995, when the bank’s current 2 percent
inflation targeting framework was implemented, to the start of the last
recession in Canada.  “Over a 3- to 10-year horizon, the normal or
“neutral” rate for Canada is likely to be lower than the historical
average of about 4 percent, due to fundamental shifts in domestic and
world determinants of desired saving and desired investment,” said Paul
Beaudry. “This is good news for borrowers, particularly the younger
generation of Canadians, but problematic for savers, such as those
entering retirement.”

The authors point to long-term shifts in global savings and investment
that suggest the world equilibrium rate of interest will remain low in
the next three to 10 years. Most notably, this is because desired
saving, both domestically and internationally, is expected to remain
high. In Canada, as in other developed countries, a large cohort of 
babyboomers is edging towards retirement and, in the meantime, is
increasing its saving level. Once the majority of this cohort enters
retirement, they will start drawing down on their saving, but given the
fact that the youngest babyboomers are still under 50 years of age and
that the retirement age is bound to increase, the bulk of this effect
will not occur during the authors’ 3- to 10-year horizon.

Possibly the most important long-term shift, they say, is the rise of
China and the concomitant rise in its level of savings by households.
Due largely to the lack of a western-style social safety net, Chinese
households have a high level of precautionary savings. Further, the
continued growth of the Chinese middle class, which typically saves a
relatively high proportion of its income, is likely to contribute to
keeping the country’s household saving rate at elevated levels. The
“Great” Recession of 2008-2009 has also affected desired savings. As
with similar past events, the fallout from the Great Recession is
characterized by deleveraging, whereby households, businesses and
governments are trying to reduce their debt levels.

“When the Bank of Canada starts gradually raising rates, it should raise
them to levels below the historical average, according to our baseline
scenario,” concluded Beaudry.

For the report go to: http://www.cdhowe.org/the-new-normal-for-interest-rates-in-canada-the-implications-of-long-term-shifts-in-global-saving-and-investment/21821

SOURCE C.D. Howe Institute

Source: PR Newswire