David Rosenberg Is Absolutely Right

David Rosenberg is absolutely right here in his article. The Central Bank of Canada definitely needs to hold its fire on upping interest rates. As he says "It's like eating potato chips -- you can't stop at just one (Rosenberg, 2010)." In other words, if the Central Bank begins a rate increase now, even a cautious small one, it will cause a chain reaction of increases by other banks throughout the Canadian financial system and might cause a catastrophic sudden deflation in the Canadian currency that could affect the foreign currency exchange markets. This would cause a constriction of the available credit money exactly at a time of recession when it is needed to prime the economy and stimulate growth.

As Rosenberg points out that inflation is an acceptable 2%, it is not necessary to invoke the banks money transmission mechanism of monetary policy right at this time. The central point of Rosenberg's argument is that the central bank's policies that are meant to guarantee stability should not only hedge against excessive inflation, but also that it needs to remember that it issues credit money into the system to ensure that there is enough in the system. Indeed, the day-to-day injections or withdrawals of credit money from the system, as seemingly temporary as they might, they could indirectly trigger another economic contraction at a time when unemployment stands at 8% and with underemployment added, this goes to 12% (ibid).

In essence, Rosenberg is advocating a return to Keynesian basics like many in political financial circles are in the present recession. The conduct and the transmission mechanism of monetary policy is the spoke of the wheel of the foreign currency market, the demand and supply of money and of the relationship of money and inflation. However, by doing so, he is also recognizing the limits of the theory that embeds the foundation of modern money theory. Monetarists do not describe the specific ways that the money supply affects aggregate spending. The reduced-form evidence has one big disadvantage, it is only a prediction. It is not exact and can result in mistakes, in this case crucial mistakes (Mishkin, 2002, 604).

Rosenberg points out that even though Canada began a 5 per cent burst of GDP growth in the final three months of 2009, this essentially constitutes digging Canada out of a deep economic hole that the recession had dropped it in. When this fact is analyzed, it becomes apparent that caution is necessary. (ibid) What he criticizes is what he suggests is the backward looking nature of the monetary policy of the Central Bank and they need to start looking at what will happen in the future. As he points out, the U.S. Federal Reserve has already made this realization and that they have pledged not to touch rates at the present time. Canada's economy does not operate in a total vacuum. Canada is an integrated piece of the world economy as the world economic recession indicated graphically in 2008. The Fed was advocating this specifically due to the deflationary shock of the European debt crisis. They know the fragile nature of the present economic situation. What Rosenberg hopes is the Bank of Canada does not make the same mistake that it did in 2002 when a premature tightening hobbled the Canadian economy (ibid).