Published in the Financial Post on August 19, 2011
By Philippe Bergevin and Finn Poschmann
In Ottawa Friday, Minister of Finance Jim Flaherty and Bank of Canada governor Mark Carney gave their updates on the Canadian economy. The big question: How does the darkened global picture affect Canada’s economic prospects and the federal government’s ability to return to a balanced budget on schedule?
By most accounts, the Canadian economy is doing well. The United States entered recession, defined as a significant decline in economic activity, in December 2007 (see graph above). Canada entered recession later, in fall 2008.
And Canada’s recession was shorter: the U.S. economy contracted for 18 months, while the Canadian economy was starting to grow again in June 2009, less than 10 months after its recession’s start. And while the United States is still short of the employment numbers seen before the start of the recession, Canada has not only recouped lost jobs, but added close to 600,000 since summer 2009.
Other indicators give cause for concern over the current recovery’s sustainability. The volatility that recently gripped financial markets — with the Dow Jones average showing lows and highs 1,000 points apart in the past 10 days, and gold hitting record highs Friday — is only a symptom. The global economic recovery lacks momentum.
The most worrisome prospect for Canada and the world: a double-dip recession in the United States. This outcome, while not yet the most likely one, is becoming more probable: The U.S. manufacturing index just posted its worst reading since July 2009.
What does this mean for Minister Flaherty and governor Carney, or for the federal budget and Canadian monetary policy? Budget 2011 assumed real GDP growth of between 2½% and 3% from 2012 to 2015, which still appears doable, although risks are on the downside. The United States’ dipping back into recession would require revising these numbers downward, delaying Canada’s planned return to a balanced federal budget, otherwise expected by 2015.
And events put governor Carney, too, in a difficult position. The U.S. Federal Reserve has all but promised to keep the federal funds rate, its policy rate, at close to zero through at least mid-2013. In Canada, the overnight rate already stands higher, at 1%. In theory and mostly in practice, Canadian monetary policy is independent of the United States, but the bank is always wary of big interest rate differentials, because a rising exchange rate feels like tight monetary policy from the point of view of Canadian exporters, which puts a damper on growth.
Further, inflation has sailed uncomfortably above the bank’s 2% target for three consecutive quarters. Interest rates will eventually need to go up, regardless of what the U.S. Fed does, but as governor Carney said Friday, recent “considerable external headwinds” justify caution over how soon and how fast rates here should be raised.
Abroad, a slowdown brings a mixed message for the Canadian economy, yet there are reasons for optimism. Domestic financial-market conditions are sunny for borrowers and lenders. Worries over high debt are well founded, but the housing market continues to shine. Labour markets likewise radiate a fair-weather story. Global weakness that depresses energy and commodity prices will pinch domestic earnings in those sectors, but won’t push resource profits into negative territory. Lower commodity prices will put downward pressure on the loonie, improving price competitiveness for our exporters.
Meanwhile, sales of Canadian goods and services in the United States still account for more than a fifth of our output: a drop of 5% in U.S. demand could translate to a 1% hit to real growth here. Canada is not an island, and positive market factors cannot undo the arithmetic of globally interlinked economies.
The financial crisis was painful and economic recovery will be slow, punctuated by ups and downs. Pauses or reversals routinely emerge during recoveries, as people and businesses try to make sense of new and volatile economic realities. Yet those are the vagaries of economic life — policymakers’ job is to provide the prudent fiscal foundation and supple monetary environment within which the rest of us can do our own best planning.
Philippe Bergevin is a policy analyst at the C.D. Howe Institute; Finn Poschmann is vice-president, research.
