Adapt to lower growth and returns, says BoC’s Wilkins

As the growth potential of the global economy falls and as central banks struggle to provide stimulus, the private sector and policymakers will have to take steps to mitigate risks, said Bank of Canada senior deputy governor Carolyn Wilkins in a speech today to the Official Monetary and Financial Institutions Forum in the U.K.

Heading off risks won’t be easy, she suggests, noting that investors and market participants will have to adapt to lower neutral rates. Further, countries must continue to work to meet their G20 commitments as well as take fiscal and structural measures to improve long-term growth and productivity, says Wilkins.

Read: When will government stimulus impact growth?

The current evironment is tough to deal with, she says, because “we typically link financial stability risks to unsustainably high growth, [but] slower growth and lower returns can also add to vulnerabilities in the financial system.”

Read: Feds to put financial sector to the test

And, economies around the world face the prospect of sluggish growth because the two components driving potential output—labour supply and productivity—are rising more slowly than in the past, she adds–the Bank of Canada estimates that global potential GDP growth declined from a peak of about 5% in 2005 to just over 3% this year.

Read: U.S. economy won’t peak until 2018 or beyond: survey

Wilkins notes, “Natural by-products of slower potential growth are not only weaker corporate profits and dividends, but also a lower average rate of return on investments.”

To gauge this effect, economists estimate the neutral rate (which is the interest rate needed to balance savings and investment when the economy is operating at potential), and that’s fallen in Canada to 1.25% today, from 3% in the early 2000s.

Further, with the Bank’s policy rate currently at 50 basis points, she notes that monetary policy in Canada remains quite stimulative–although less so than it would have been a decade ago when the neutral rate was higher.

Read: Canadian economy shrinks in worst showing since financial crisis

Wilkins says slower growth and a lower neutral rate heighten financial vulnerabilities through several channels. For starters, households could experience longer and more frequent periods of shrinking incomes, making their debts more burdensome.

As well, a lower neutral rate could encourage investors to take on more risks in their search for higher returns. And, lower rates put pressure on bank business models. “We have to adapt to the new reality of lower potential growth,” Wilkins says. “The faster we do this, the safer the financial system will be.”

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.