Reference no: EM132405979

1. You are the chief monetary policy advisor to the Governor of the Bank of Canada. The Bank of Canada maintains a CPI inflation target of 2 percent with a control range of 1 to 3 percent. The Canadian economy is recovering from a roughly one-year slowdown in real GDP growth to just above zero growth in H2:2018/H1:2019, led by the impact of global trade conflicts on exports, trade-related uncertainty on investment, falling commodity prices, especially oil, and weakness in housing, which boomed for many years.  Canada is a major exporter of commodities.

In its July 2019 Monetary Policy Report, the Bank projected GDP growth of 1.3 percent in 2019, and around 2 percent in both 2020 and 2021.  Canada's potential growth rate is estimated to 1.8 percent. The major factor in the projected rebound is the Bank of Canada's assumption that global trade conflicts will ease. It sees exports and investment rising, a resumption of growth in the emerging market economies, and a rise in commodity prices, giving Canadian households and producers a large gain in the terms of trade. The Bank expects inflation, which was 2.24 percent in 2018, to be around 2 percent in 2019 and 2020. Canadian unemployment is 5.7 percent, just above the post-war historical low of 5.6 percent.

The Canadian dollar exchange rate has hovered around a relatively weak C$ 1.33/US dollar for the last four years. It depreciated around 25 percent from its value in the early 2010s. Canada's largest trading partner by far is the United States, with 75 percent of Canadian exports going to the U.S. U.S. growth is slowing, the Federal Reserve is easing monetary policy, and US inflation is slowing.

The Bank of Canada Governing Council will be meeting at the end of the month. US financial markets are expecting another Federal Reserve policy interest rate cut from its current 1.75 to 2 percent target range. While the US stock market continues to remain strong at high levels, surveys of business and CEOs reflect continued concerns about trade policy uncertainty and indications of a U.S. economic slowdown are increasing.

What is your advice to the Governor about the Bank of Canada's monetary policy stance as it sets the Canadian overnight interest rate target, currently 1.75 percent?

a. What should the Bank of Canada do with in light of the current domestic economic situation, based on the information above? 

b. What impact would a U.S. slowdown and potential interest rate cut have on Canada?

c. The Bank of Canada was assuming that trade policy uncertainty would dissipate. In your view, how much should the Bank factor trade policy uncertainty about US-China trade and Brexit into the monetary policy decision? Why or why not?