On Wednesday, the Bank of Canada issued its regular monetary policy report. To no one’s surprise, the Bank maintained its overnight rate at one per cent.

But the real message wasn’t the setting of the bank rate. That rate hasn’t changed since September 2010. The real message is that Governor is very concerned about the prospects for the Canadian economy. There is simply not enough aggregate demand in the economy and the prospects are not that certain.

Underlying Inflation is moving further below the official target of 2 per cent and he attributes this “to excess supply in the economy and heightened competition in the retail sector”. Since when was market competition a cause of sustained disinflation? But even the Governor is unsure about of what is really happening. He candidly admits the Bank has an “incomplete understanding of the inflation picture”.

The Governor is expecting growth to pick up to 2.5% in 2014 and 2015, but he doesn’t sound very confident about his own forecast. On the one hand, he acknowledges that the “the U.S. recovery is becoming more broad-based”, but on the other hand, “the wedge between the level of Canadian exports and that of foreign demand remains difficult to explain”.  Despite recovery in the U.S, “there have been few signs of the anticipated rebalancing towards exports and business investment in Canada.”

These forecast growth rates are roughly in line with the rates in Mr. Flaherty’s Fall Update.  Sounds great, but as the Governor says these higher rates of growth still imply “that the economy will (only) return gradually to capacity over the next two years or so”. In other words about seven years after the recovery started. The U.S. economy, which suffered a more sever recession will actually get back to full utilization of resources before Canada. We are definitely not the best in the G-7 any longer.

Reading between the lines suggests that the Bank does not expect a strengthening in employment growth and any significant reduction in the unemployment rate over the next eighteen months; in other words before the 2015 election. And there is very little the Bank can do, short of lowering the overnight rate further.

The simple fact is that there is a need for more aggregate demand in the economy. This has been the case for the past three years. Since 2010, growth in output and jobs has been falling and in 2013 only 102,000 net jobs were created; 60,000 full time jobs were lost in December alone. There has been growing unused capacity in the Canadian economy for the past four years.

Both the Bank and the Government’s response to this shortage of aggregate demand have been to try and engineer a lower dollar to help exports, particularly exports of manufactured exports. Exchange markets are very unpredictable in how they react to such attempted “manipulation”. Based on our experience in the 1990s, the best advice we have for the Governor and Mr. Flaherty is “be careful for what you wish for”. In the end it is always the exchange market that wins. You may get a lower dollar but you have no idea and no control over what that level might be.

Unfortunately, Mr. Flaherty is simply not prepared to do what is necessary to raise aggregate demand in the economy. For years the government’s strategy has been to reduce the deficit (which it created) and hope that exports and investment would back-fill in the gap. This hasn’t worked.

Despite this, Mr. Flaherty’s still believes the answer to insufficient aggregate demand is to eliminate the deficit by 2015-16. Even the International Monetary Fund thinks this policy is wrong.  In its review of Canada in October it recommended that, in the absence of a strong recovery in growth and job creation, the date of deficit elimination could be delayed.

Answer the phone Mr. Flaherty the Governor would probably like more than a “bare-bones” budget in 2014 to deal with inadequate aggregate demand, excess supply, high unemployment.