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The Bank of Canada just said the 3 most controversial words in central banking: 'negative interest rates'

Dec 9, 2015, 00:36 IST

Bank of Canada Governor Stephen Poloz takes part in a news conference upon the release of the Monetary Policy Report in Ottawa January 21, 2015. REUTERS/Chris Wattie

The governor of the Bank of Canada just said the three most controversial words in central banking: "negative interest rates."

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In a speech on Tuesday, BoC Gov. Stephen Poloz discussed some of the bank's framework for thinking about potential responses to future incidents of financial distress.

And among the tactics the BoC could choose to take in the future, Poloz mentioned negative interest rates. This is something central banks in Switzerland, Denmark, and Sweden and - most notably - the European Central Bank have all put in place.

"The fourth unconventional monetary policy tool I want to cover is negative interest rates, which is something you have heard a lot more about recently," Poloz said in his speech given at The Empire Club in Toronto.

Poloz added:

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In 2009, the Bank said it couldn't cut its policy rate below 0.25 per cent, because we believed that zero or negative interest rates might be incompatible with some markets, such as money market funds. This was a common view at the time.

Since then, we have seen the experience of several central banks, such as the ECB and Swiss National Bank, which have adopted negative policy interest rates. There, we've seen that financial markets have been able to adapt and continue to function. Given these and other developments, the Bank is now confident that Canadian financial markets could also function in a negative interest rate environment.

Now, Poloz cautioned that this is not something being actively discussed by the BoC. Currently, the BoC's benchmark interest rate is pegged at 0.5%.

But as we wrote last week, Citi's Willem Buiter is among those discussing the possibility of additional central banks around the world taking interest rates into negative territory.

Like Buiter, Poloz also discussed how the theoretical challenges of putting negative interest rates in place have been overcome in practice, the main reason being that hoarding cash isn't free as it requires physical space and insurance.

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This runs, as Poloz said, counter to the "common view" that taking rates into negative territory would sort of create something like a malfunction in the banking system.

And while the idea of negative interest rates might make a normal citizen like you, dear reader, fear that money being held in a bank will be taxed on some sort of regular interval, no retail bank has as of yet put these policies into place. Moreover, the types of deposits at central banks that are or could be subject to negative rates are not those held by private depositors.

All in, then, Poloz is just sort of laying out a potential framework for how the BoC might, at some future date, think about combating a financial crisis.

Earlier this year, at least one Federal Reserve official - widely believed to be outgoing Minneapolis Fed president Narayana Kocherlakota - recommended the Fed take interest rates into negative territory. And now Poloz has at least discussed the possibility as the world continues to work through what modern banking really can or cannot be.

NOW WATCH: Fed's Bullard explains the problem with keeping rates at zero forever

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