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Because policymakers like Tiff Macklem and Kevin Warsh take a long-term view of neutral rates, they “look through” the effects of seismic economic events, said Royce Mendes. (Credit: HYUNGCHEOL PARK\/Postmedia\/Andrew Harnik\/Getty Images) <\/p>\n
Bank of Canada<\/a> governor Tiff Macklem<\/a> and United States Federal Reserve<\/a> chair nominee Kevin Warsh<\/a> are misinterpreting the effect of productivity on the economy<\/a> and what it could mean for interest rates<\/a>, says a Desjardins Group economist.<\/p>\n \u201cThe problem that both of them make is that they are tying just one variable, which is the potential of the economy, to where interest rates should be set,\u201d Royce Mendes, managing director and head of macro strategy at Desjardins Group<\/a>, said.<\/p>\n That misinterpretation is leading them to potentially make mistaken estimates of the neutral rate and, consequently, decisions around interest rates. Canada\u2019s neutral rate, which is calibrated to neither stimulate nor depress economic growth, ranges from 2.25 per cent to 3.25 per cent.<\/p>\n Warsh, in front of a U.S. Senate confirmation hearing last week, said an artificial-intelligence-led productivity boom won\u2019t lead to higher inflation, thereby leaving room to cut the Fed\u2019s benchmark interest rate.<\/p>\n However, Mendes, in a note on April 22, said economic theory has established that productivity increases<\/a> when capital spending rises, pulling along consumers who end up saving less. Increased spending spurs demand and inflation typically comes along for the ride.<\/p>\n Macklem, during a speech earlier this year, said lower productivity leads to weak growth, so cutting interest rates can risk \u201cstoking future inflation\u201d and delaying \u201cneeded structural change.\u201d<\/p>\n But Mendes said a lower productivity scenario or a lower potential output scenario are not sufficient reasons to expect lower interest rates to stoke inflation. He said the problem regarding rate setting is which version of the neutral rate is being used \u2014 at least in today\u2019s environment.<\/p>\n The benchmark lending rate is currently 2.25 per cent, and he said policymakers have made a few references to their belief that rates are in stimulative territory.<\/p>\n The Bank of Canada will release its annual estimate of the neutral rate along with its latest interest rate decision on Wednesday.<\/p>\n