Negative interest rates an option in Canada, Stephen Poloz says

Canada could theoretically follow the lead of other countries that have recently gone to negative interest rates in order to stimulate the economy, central bank governorStephen Poloz told a business audience today after yet another drop in the loonie.

Speaking to the Empire Club in Toronto, Poloz said moving its benchmark interest rates below zero is somethingin the Bank of Canada'smonetary policy toolkit that the bank may consider down the line.

That's a departure from 2009, when the bank said its theoretical lowest-possible interest rate was 0.25 per cent because to go lower would have been incompatible with certain financial markets, such as money-market funds.

• ANALYSIS: Why Canada's central bank may be happy to see inflation creep higher

"The bank is now confident that Canadian financial markets could also function in a negative interest rate environment," Polozsaid.

Poloz was speaking afterthe Canadian dollar today shed another half-cent from the previous day,dropping to a new 11-year lowunder 74 cents US.

But while Polozopened the door to the possibility of negative interest rates, he stressed in English andFrench that the bank has no current intention to do so.

"Today's remarks should in no way be taken as a sign that we are planning to embark on these policies," Poloz said."We don't need unconventional policies now, and we don't expect to use them. However, it's prudent to be prepared for every eventuality."

The Bank of Canada twice this year cut its benchmark interest rate in an attempt to stimulate the economy.

But other countries have gone even further, slashing theirrates below zeroin an attemptto encourage spending and investment, instead of fearfully hoarding capital.

Switzerland, Sweden, Denmark andthe European Central Bankhave all dipped their benchmark rate below zero for various reasons in recent years. Switzerland's central bank rate is now minus 0.75per cent, for example. That means banks must pay a fee to store money with the central bank something that encourages them to not do so, and deploy their capital into other investments that grow the economy.

• Swiss Central Bank sets negative rate in order to devalue their currency
• ECB adopts negative interest rate to head off deflation

"Why would anyone ever accept a negative nominal return when they could always simply hold cash and earn a zero return?" Polozasked, rhetorically."A big part of the answer is that there are costs to holding currency, particularly in large quantities, and these costs affect the lower bound. Because of the costs, which include storage, insurance and security, central banks can charge negative rates on commercial bank deposits without seeing a surge in demand for bank notes.

To put it simply, the Bank of Canada now thinks negative interest rates are a policy option in its tool belt because the experience of other countries that tried them wasn't calamitous. Negative rates, to varying degrees, achieved their goals without any undue negative consequences.

But that doesn'tnecessarily mean that Canadian consumers would actually see negative interest rates a mortgage that pays you to hold it, for example even if the central bank goes negative, Poloz said, citing examples of what happened in other countries' consumer lending markets once the central bank went below zero.

In those cases, commercial banks swallow the relatively small costs of the central bank's lending rate without ever directly passing it on to their own customers by charging fees to hold deposits.

"Interest rates don't go below zero for savers," Polozsaid at a question-and-answer session following his speech, noting that in Switzerland and elsewhere, consumers still earn microscopic amounts on savings and pay tiny interest rates on consumer loans."We would expect the same sort of behaviour here," he said.

"We now believe that the effective lower bound for Canada's policy rate is around minus 0.5 per cent, but it could be a little higher or lower," Poloz said.

• Neil Macdonald: The high cost of low rates for savers

But negative interest rates weren't the only central banking tools that Poloz discussed in Tuesday'sspeech.

Poloz announced another new unconventional measure added to the bank's arsenal: Funding for credit.

The option would ensure economically important sectors had continued access to funding even when the credit supply isimpaired, Poloz said. That's exactly what happened in 2009 when the Canada Mortgage and Housing Corporation (CMHC)took mortgages off the books of Canada's big banks to free up cash for them to lendmoney to deserving borrowers.

"This program was clearly aimed at one market segment that was at risk of impairment and so had a similar purpose to funding for credit," Poloz said.

Poloz also said fiscal stimulus tends to be a more powerful tool than monetary policy in extreme crises.

All in all, Poloz reiterated his optimism for the Canadian economy and reaffirmed his projection it was strengthening despite the pain of persistently low resource prices. The non-resource sectors, Poloz added, have continued to strengthen.

"We will continue to watch how these policies work in other economies and adjust our own thinking at the Bank of Canada as appropriate," Poloz said."In short, should the need arise, we'll be ready."