Bank of Canada: can't take lead in maintaining financial stability

(Adds details from speech, background)
By Jonathan Montpetit
MONTREAL, Feb 8 (Reuters) - Central bank policy cannot take
the primary responsibility for maintaining financial stability,
with interest rates being too blunt an instrument to address an
imbalance in one part of the economy, Bank of Canada Deputy
Governor Timothy Lane said on Monday.
While Lane noted that stimulative monetary policy might
cause vulnerabilities to build up over time, he said failing to
ease in an economic downturn could worsen the contraction,
causing a crisis.
Lane laid out the case for macro prudential tools to be used
to promote the safety of the financial system, allowing for
monetary policy to target inflation.
"Monetary policy cannot take primary responsibility for
maintaining financial stability," Lane said in a prepared text
of a speech. "Other prudential tools are required to build a
resilient financial system and, where needed, to address
increasing vulnerabilities."
After cutting rates twice last year to offset the pain of
the oil shock, the bank held steady at its most recent rate
decision last month, partly out of concern of the impact of the
rapid drop in the Canadian dollar.
The bank's easing last year led to concern the low borrowing
costs would exacerbate already high household debt as home
prices have climbed in parts of the country.
Research at the bank estimates that increasing the bank's
policy rate by 1 percentage point for one year would reduce
household debt by 2 percent over five years, Lane said, but the
same increase might cut output by up to 1 percent and push
inflation down by 0.5 percentage point compared to where it
would have been otherwise, Lane said.
"These results suggest that, even though monetary policy
could, in principle, be used to reduce vulnerabilities in the
financial system, it may be too costly in practice," he said.
"Interest rates affect all parts of the economy and are too
blunt an instrument to address an imbalance in just one part of
the economy - household credit."
Lane said the bank has been doing research to improve its
understanding of the relationship between monetary policy and
financial stability, which is a key question in the central
bank's renewal of its inflation control agreement with the
government this year.
Markets are pricing in about a 76 percent likelihood the
bank will hold at its next meeting in March. BOCWATCH