A new way for the BOC to look at the risks
From the BOC:
"Monetary policy decisions need to consider all potential outcomes, not just the most likely path for the economy. This is especially true in the presence of elevated financial system vulnerabilities, which lead to increased downside risks for future growth. In a novel risk-management framework, we decompose the outlook for thedistributionof future gross domestic product (GDP) growth into macroeconomic and financial stability risks. When analyzing the efficacy of policy tools, we find that macroprudential tightening is substantially more effective than monetary policy at reducing downside risks to future GDP growth."
Here's how Poloz describes it:
"As you can imagine, getting the path of monetary policy right involves a lot of judgment. Bank staff have recently developed an important new way to evaluate these trade-offs and help inform this judgment, and we are publishing a staff analytical note today on this work.
Briefly, the framework uses our models to calculate the risks to the economy associated with various hypothetical interest rate paths. By examining many such paths, we are able to sketch the trade-offs involved in choosing any particular path. Intuitively, higher interest rates will mean slower economic growth; but they will also mean reduced financial vulnerabilities. As a result, the impact on the economy of a major financial stability event would be less.
From this starting point, the framework then allows for the inclusion of macroprodential policies, such as the new mortgage guidelines. By reducing financial vulnerabilities directly, macroprudential policies improve the trade-off policy-makers face in choosing when to adjust interest rates higher. Put another way, macroprudential policies allow monetary policy to deliver similar results for growth and inflation without exacerbating financial vulnerabilities."
Read the framework here.
