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Central banks are at their limits, so governments must step in to save their economies

Updated: Mar 29, 2021

Opinion by Liz Chamberlain

When something goes wrong with the economy, there are generally two types of responses taken––monetary policy and fiscal policy. During the COVID crisis in both Canada and the US, central banks that control monetary policy responded quickly, lowering interest rates so it was cheaper to borrow money and make it through the crisis (a phenomenon referred to as the expansion of credit). This, however, has not been followed by appropriate levels of fiscal policy responses, the role of elected governments in dispensing financial support to individuals, households, and businesses.

The problem with this uneven response is a concept called zero-lower bounds: in simple terms, there is a limit to how far monetary policy can go. The official interest rate in Canada is 0.25% (Bank of Canada) and in the US it ranges from 0-0.25% (Board of Governors of the Federal Reserve System 2020). This is concerning, as it means the banks have very little room to further stimulate the economy by lowering interest rates—they are effectively already at their limits. At a 0% interest rate or lower, the theory goes that it is cheaper to hold cash than an investment, as the inflation rate on cash would be higher than that of interest on investments. While some countries have had negative interest rates for long periods with success, the existence of some limit on the power of expanding access to credit is accepted, but where exactly it is isn’t known (Witmer and Yang 2016). That being said, the Bank of Canada and the US Federal Reserve have been reluctant to go into the negatives.

So what does this mean? It means that central banks have done most of what they can do, and it is up to fiscal policy to fill in the gap that remains. For the US, this means an approval of a renewed CARES Act, providing financial support, in any form possible. Right now, this extension of financial support passed by Congress in the Spring is stalled by political stalemates between the Democrats, who want extensive supports, and the Republicans who are worried about excessive spending (Elis 2020). I would argue that while this is not the time to worry about austerity as the Republicans are doing, the Democratic position of ‘all or nothing’ is equally damaging. Not passing any financial support because you can’t get all of what you want means the US economy is relying increasingly on monetary policy for support when it has exhausted its limits.

This is why the Chair of the Federal Reserve (the US central bank) is pushing Congress for more support, stating that “too little support would lead to a weak recovery,” while “the risks of overdoing it seem, for now, to be smaller.” He argues that “the recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side,” a call-out to Congress on the delay in fiscal response (Powell 2020).

In Canada, the fiscal response has generally seemed better, with a swift roll-out of CERB and other benefits. However, there is still so much to be done, especially as CERB switches to other programs, youth remain largely unsupported, and businesses continue to require more than rent and wage support. Monetary policy by its very nature does not reach the economically marginalized, as cheaper borrowing only really matters for those with enough wealth to borrow.

With monetary policy at its zero-lower bound and so many left unsupported even with this firepower used, federal governments need to step in and take decisive action to financially support people. As Chairman Jerome Powell said, the risk of overdoing it is small, and the risk of underdoing it is huge. We must weigh those risks appropriately.



Bank of Canada. n.d. Bank of Canada. Accessed October 16, 2020.

Board of Governors of the Federal Reserve System. 2020. The Fed - Monetary Policy: Monetary Policy Report. June. Accessed October 15, 2020.

Elis, Niv. 2020. Expiring benefits raise economic stakes of stalled stimulus talks . October 18. Accessed October 18, 2020.

Powell, Jerome H. 2020. "Speech by Chair Powell on Recent Economic Developments and the Challenges Ahead ." Board of Governors of the Federal Reserve System. October 6. Accessed October 16, 2020.

Witmer, Jonathan, and Jing Yang. 2016. Estimating Canada's Effective Lower Bound. Ottawa: Bank of Canada Review.

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