MNI POLICY: BOC Analysts: Higher Rates Can Blunt GDP Tail Risk

--Independent Staff Paper Says Household Credit Biggest Challenge

By Greg Quinn

     OTTAWA (MNI) - Central banks can blunt the "tail risk" of an economic slump

if their policy moves aren't so dramatic they throw GDP growth off course,

according to a paper by BOC researchers published Thursday. 

     Macroprudential regulations can head off the rapid expansion of household

credit, the major growth risk in the medium term, according to an independent

paper by Thibaut Duprey and Alexander Ueberfeldt in the BOC's financial

stability branch. 

     Their work may help policymakers communicate reasons why they would choose

a policy aimed more toward longer-term financial risks than economic growth, the

authors wrote. Governor Stephen Poloz and his predecessors have said the BOC's

2% inflation target already gives some flexibility for financial strains, but

that the price goal must take priority.

     "Our framework can add crisis risk to macroeconomic forecasts that usually

ignore it and give policy-makers a tool to effectively communicate the

trade-offs they face," the authors wrote.

     They ran economic simulations reviewing historical Canadian growth data and

looking at 31 macroprudential rule changes since 1992. The results showed that

tightening monetary or macroprudential policy can diminish the chances of a

downturn, while more extreme moves would alter the economy's growth path.

     "Very strong tightening, however, generates a trade-off between worsening

risks to the central path and improving GDP tail risks," the paper said. "A

policy-maker concerned about financial stability, and aware of the build-up of

tail risk, would prefer a tighter policy stance than otherwise."

     The BOC has said the buildup of record consumer debts and surging home

prices are a key vulnerability to the economy. Poloz avoided last year's wave of

global rate cuts citing resilient domestic spending and signs the housing market

was heating up again. 

     "Both monetary and macroprudential policy shocks can reduce credit growth"

and reduce tail risks to GDP, they wrote. "Household credit growth is the main

driver of GDP tail risk in the medium term."

--MNI Ottawa Bureau; +1 613-314-9647; email: greg.quinn@marketnews.com

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