From: Doug Porter
To: Policymakers and Concerned Canadians
Date: May 30, 2016
Re: Canadian Macro Policy: The Mix is In
The world has witnessed an important shift in policy prescriptions recently. After years of urging fiscal restraint on deeply indebted governments following the financial crisis, as well as ever-easier monetary policy, the conventional wisdom appears to have undergone a rethink.
With interest rates pressing against, or even pushing through, the lower boundary almost across the OECD and growth still disappointing, there is the dawning realization that the limits of monetary policy are fast approaching. Now, those governments that have any wiggle room to embark on fiscal stimulus are being actively encouraged to do so—even by a variety of central banks, who are looking for help. Indeed, Canada has been widely lauded for its fiscal policy gear change in 2016, with Ottawa swinging from a roughly balanced budget to a 1.5% of GDP deficit within the short space of a year. Meantime, the Bank of Canada has kept policy studiously on hold since mid-2015, and openly suggests that it would take a significant shock to prompt further easing.
Is this an appropriate policy stance for Canada? To start, we should ask whether the economy is even in need of stimulus. The short answer is a qualified yes. Canada is one of only three countries in the OECD where the unemployment rate has risen in the past year. And, Canadian GDP growth has struggled to stay above 1% in 2015/16, largely due to the oil shock, below even the heavily downgraded view on potential growth (now just 1.5%).
In turn, is the policy mix appropriate for Canada? Again, the answer is a qualified yes. Despite the recent talk about negative interest rates being a potential part of the BoC’s toolkit, the jury is still out—and debating heavily—on the efficacy of negative interest rates elsewhere. Moreover, the persistence of extremely low nominal rates in Canada, and deeply negative real interest rates, is further firing up consumer debt and already-steaming housing markets. Barring a much more serious setback in the economy, the Bank of Canada should be saving its few remaining rounds of ammunition for a true emergency, which the current situation doesn’t come close to meeting. Also note the extreme regional variations arising from the oil shock—little impact in the oil-importing provinces, and downturns in the three oil-producing provinces. This argues for more targeted measures, which monetary policy simply cannot deliver.
If there is a need for modest stimulus, this realistically leaves only fiscal policy. And since almost all provinces have seen their credit ratings come under downward pressure in recent years, Ottawa is the last credible option. The moderate net new stimulus of about 0.6% of GDP in this year’s federal budget is broadly appropriate in view of the economic backdrop. But it’s tough to make a case for much more action, noting that fiscal stimulus typically provides only a limited, short-term lift to growth and simply should not be viewed as a permanent replacement for private sector activity. Not unlike the Bank of Canada, Ottawa should be sparing the good health of its balance sheet for a true economic emergency, which the current circumstances do not come close to meeting.
Doug Porter is Chief Economist and Managing Director at BMO Financial Group
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