Low rates breed zombies, BoC warns

Slashing interest rates and printing wads of money may have saved the global economy from catastrophe, but it also gave rise to “zombie” firms; and taking back all the monetary candy opens the world to new risks, the Bank of Canada warns in a research paper.

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The paper, written by economists Eric Santor and Lena Suchanek as part of the institution’s quarterly Bank of Canada Review, says efforts to stimulate the economy through the 2008-09 recession appear to have worked but risk remains.

“Exiting too soon could undermine the recovery, while too slow an exit could lead to excess liquidity and contribute to inflationary pressures,” they write.

The economists also make clear the successes so far have not come without costs — mostly punishing savers by pushing down interest rates and yields on safe investments, such as government bonds.

They note low rates over an extended period allow “otherwise non-viable firms and/or banks to continue operating. These ‘zombie’ firms/banks would impede the needed restructuring of the economy.”

The paper appears more directed at central bank policies in hard-hit economies such as Europe, Japan and the U.S., which radically increased the money supply through a policy known as quantitative easing.

The Bank of Canada never took that step, but did slash interest rates to close to zero in 2009 and still retains a super-low overnight rate of one per cent.

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In a report issued Wednesday by the C.D. Howe Institute, former Bank of Canada special adviser Paul Masson argued that it was time for Canada’s central bank to start hiking interest rates.

He cited some of the same risks to keeping rates low for long periods as the new Bank of Canada paper — creation of asset bubbles, as households take advantage of easy money conditions to purchase homes. As well, market distortions and risks as low yields hammer pension funds and insurance companies, which might be driven to riskier ventures to meet their longer-term liabilities.

The Bank of Canada economists, however, do not offer an opinion on when to begin pulling back the stimulus, but agree that almost five years of super-low interest rates have come at a cost.

Removing stimulus poses new risks, the economists add, including that central banks themselves could suffer losses from the risky assets they acquired.

A bigger problem may arise if all the money central banks have poured into the system comes back to haunt them by spiking inflationary pressures.

Still the authors say the central bank experiment with monetary easing was worth the potential price.

“On balance, research to date suggests these measures were, and remain, effective. Without them, economic outcomes would have been much worse,” they say.

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