INTEREST RATES: Central bank may keep rates low

The Bank of Canada could keep its benchmark interest rate accommodative through 2015 to offset fiscal restraint by the government, which must increase taxes to balance its budget, former central bank governor David Dodge said yesterday.

In point-form notes for a speech he was delivering at a business forum in Lake Louise, Alta., Mr. Dodge backed the plan by his successor, governor Mark Carney, to hold interest rates at near zero until mid-2010 but said the bank could back away from "unconventional initiatives."

With a credible fiscal plan, the overnight target rate, now at the lower limit at 0.25%, could "remain accommodative through 2015," he said.

The rate could rise to 2% in 2010-11 but stay below neutral for the rest of the period, he said, to compensate for the "fiscal drag and continuing [small] output gap," Mr. Dodge wrote in his notes.

Mr. Dodge, governor until January 2008 and now a senior advisor at Bennett Jones LLP, said any credible plan to eliminate the federal government's fiscal deficit by 2015 would likely include tax increases.

That conflicts with the Conservative government's promise to refrain from any politically unpopular tax hikes to balance its books, vowing to rely entirely on economic growth and a lower rate of growth in program spending.

Mr. Dodge argued that if the federal government focused its efforts solely on the spending side, spending -- including that to service debt -- would have to be reduced to zero real growth between 2012 and 2015.

This assumes all temporary stimulus spending ends by year-end 2011.

"Restraint of this magnitude is very difficult and disruptive, so some tax increases will be necessary. Consumption taxes would be least harmful to long-term growth," he said.

The government's fiscal plan must include a mix of expenditure cuts and tax increases that have a combined impact of 3% of gross domestic product, he said.

Ottawa fell into deficit last year after a decade of surpluses, and projects a shortfall in the 2009-10 fiscal year of $56-billion.

Yesterday, the government reported an accumulated deficit in the first six months of the current year of $28.64-billion, compared with a surplus of $535-million in the same period a year earlier.

(Source: National Post)