Bank of Canada deputy governor Carolyn Wilkins, left, with governor Stephen Poloz. (Sean Kilpatrick/CP)
In August 2012, former Bank of Canada governor Mark Carney derided Corporate Canada for sitting on a large pile of “dead money.” In effect, Carney called out the country’s business leaders as a bunch of wimps. Carney had orchestrated some of the lowest borrowing costs on record, and still executives executives and business owners refused to invest. But who could blame them? The European debt crisis threatened to pull apart the euro zone only a few years after the world endured the greatest financial calamity since the Great Depression. It was scary out there.
Carney took some heat for those remarks. He had an impressive track record in investment banking, but he had never run a business. Bosses grumbled that Carney was out of his element and that if there was money to be made, they would be making it. But what if Carney knew more about Canadian corporate culture than his critics cared to admit? Four years have passed and companies remain largely on the sidelines. Business investment declined for six consecutive quarters through the first half of this year, according to the most recent figures from Statistics Canada. Nor is there a reason to expect a rebound anytime soon. The Bank of Canada in July described the investment intentions of Canadian companies over the year ahead as “modest.”
Now Carney’s predecessor is trying to cajole Canadian companies to do something productive with their profits. Stephen Poloz used a speech on September 20 in Quebec City to educate a group of economists about the “hurdle rate”—the minimum return on an investment companies require before they agree to part with their money. Poloz said too many executives have refused to adjust their expectations to the post-crisis reality of slower economic growth. Carolyn Wilkins, the senior deputy governor at the Bank of Canada, said in a speech on September 14 that Canada’s annual potential growth rate—the fastest gross domestic product can expand without triggering inflation—is now a mere 1.5%. Growth rates of 3% are a thing of a past, and so are the pre-crisis returns on investment. Yet many of Canada’s business owners and executives would rather hoard cash than accept anything less than what they used to make. “Hurdle rates for new investments do not seem to have adjusted to the new reality,” Poloz said.
The Wilkins and Poloz speeches represent the most significant messaging from the central bank this year. On September 7, the Bank of Canada said it had been too optimistic about the economy’s prospects, especially exports. Yet policy makers made clear they were reluctant to cut interest rates. The speeches of Wilkins and Poloz explain why. Monetary policy still can counteract economic headwinds, but it will be less effective at stoking demand under a lower ceiling for non-inflationary growth. (The Bank of Canada estimates that the nominal neutral interest rate, or the rate at which the level of interest is neither stimulative or contractionary, is between 2.75% and 3.75%, compared with 4.5% and 5.5% before the crisis.) The risks inherent in lower borrowing costs outweigh what little would be gained from an interest-rate cut, at least under current conditions.
Both speeches were appeals to executives, households, investors and politicians to adjust to a future of slower economic growth and unusually low interest rates. Wilkins focused on heightened risks to financial stability. Her boss took up more immediate concerns, including the implications of ultra-low interest rates on retirement. Poloz broached the subject gingerly. He acknowledged that he and his counterparts around the world have made things difficult for savers, while pointing out that low inflation will at least preserve the value of their money. And then he suggested some hard truths: people will have to rethink their retirement strategies, including the possibility of working longer. “The difficult reality is that savers must adjust their plans,” he said.
The other group Poloz singled out for counseling was companies. And if Canada’s central bank chief is openly criticizing executives, then there is a problem. There probably is no one in Ottawa who has a better appreciation of the way Canadian executives think. He met hundreds in his previous job as president of Export Development Canada, and he makes a point of meeting business leaders when he travels. Poloz generally is sympathetic to their plight. In 2013, I interviewed him for a profile in Report on Business magazine. When I asked if he thought Canada’s companies might need to be shoved off the sidelines, he responded with astonishment: “You mean, like, badger them?” He said all he could do was help create the conditions for investment. After that, it would be up to “Mother Nature” to do Her work.
Canada’s companies haven’t rewarded Poloz for his faith in them. He said in Quebec City that uncertainty about the global economy likely is the biggest reason investment remains depressed. Stricter banking regulations also may be making it harder for startups and other unproven companies to get loans, he said. But Poloz is unsatisfied with those explanations. Data suggest many non-resource companies are operating at capacity. That should be an incentive to expand, yet the Bank of Canada sees little evidence of it. So something else must be going on, which brings us back to the hurdle rate.
Poloz said the hurdle rate generally is calculated by adding the risk-free interest rate, expected inflation, and a risk premium. Therefore, if estimates of neutral rates of inflation are falling, hurdle rates should fall with them. Poloz relayed to his audience in Quebec City that he has witnessed Canadian executives express surprise that Asian companies would pursue investments that would return only 4%. Poloz said his response to these executives was to tell them that a return of that size isn’t so bad in a world where annual economic growth in Canada will be stuck below 2%.
“Hurdle rate” lacks the rhetorical punch of “dead money.” That may allow Poloz to avoid the emotional backlash that Carney endured. But Poloz’s remarks were prompted by the same frustrations as the man he replaced. Economists operate in the realm of reason and there is something unreasonable about the unwillingness of Canadian executives to take advantage of the lowest borrowing costs they will ever see. Worse, their irrational expectations are hurting the rest of us. “If companies are maintaining traditional hurdle rates, they are unlikely to invest any time soon, and we will not see the kind of growth, productivity and job creation we are looking for,” Poloz said. “And neither will the companies.”
MORE ABOUT ECONOMIC GROWTH & INTEREST RATES:
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