Our COVID-19 response: Policy actions

Our response

In the days and weeks since the COVID-19 pandemic came to Canada, the Bank of Canada has been taking action to ensure our economy and financial system are weathering the unprecedented shock of the shutdown. We have responded in two main ways. First, we have cut our key policy interest rate to 0.25 percent. Second, we have been buying bonds and other debts to help keep key funding markets functioning well.

Together, these actions are designed to set the stage for a solid recovery when the restrictions of the pandemic are lifted. The shutdown is temporary, but the restraining of so much activity can have long-lasting effects if governments, businesses and households do not have access to funding to tide them over. We are helping to ensure that such access remains available throughout the crisis.

Lowering interest rates

Lowering interest rates is the Bank’s best-known tool to encourage borrowing to stimulate the economy. In normal times, our key policy rate filters through the economy by affecting rates on things like mortgages and savings accounts at banks. But these are not normal times, and our rate cuts can do little to stimulate the economy because the shutdown means there is almost nowhere to spend. Instead, cutting rates to near zero provides support for other parts of the credit market. It helps lower debt-servicing costs for many borrowers at a time when every dollar counts. This ensures that when the recovery does start, it will have the best momentum we can give it.

Some have asked why rates can’t be lowered to zero or beyond, into negative territory—a policy that some other central banks have implemented. Negative rates happen when central banks lower their policy rates below zero and charge interest for holding bank deposits (it’s usually the other way around). We could still use negative rates if we thought it was necessary. But zero or negative rates come at a cost—they can impair the function of key funding markets. This is because investors would pull money out of short-term financial assets and hold other assets, such as cash, that don’t charge negative rates. This is particularly true if the banks pass these negative rates on to their depositors. That is the opposite of what we want to achieve at a time when the system is already under tremendous strain.

Deputy Governor Timothy Lane explains how the Bank of Canada has taken action to help the economy and financial system respond to COVID-19.

Ensuring access to credit

This brings us to the second part of the Bank’s action: the purchase of bonds and other debt from governments and businesses. Governments have ramped up spending to support Canadians who have lost jobs and income. Businesses and households need to borrow to pay their bills. An important way that governments and corporations borrow is by issuing debt securities, such as bonds, treasury bills, commercial paper and bankers’ acceptances, which are then traded in financial markets. Banks also use those markets to fund their lending to businesses and households.

Normally, there are enough buyers and sellers in debt markets so that governments and businesses as well as banks can secure funding. But in times of financial stress, the institutions that trade in those markets may pull back, preferring to hold cash rather than debt securities. If that happens, those markets could stop functioning properly, resulting in a “credit crunch.” To prevent that, one of our key roles is to make sure there is enough liquidity or cash in the system to allow transactions in debt markets to happen. By buying up bonds and other debt, we unblocked the lines of financing, smoothed the functioning of these markets, and freed up cash that companies and governments can use to pay salaries and suppliers and provide emergency benefits to those in need.