Canada: The Miracle That Wasn’t

Outgoing Bank of Canada Governor Mark Carney is making his final appearance before the House of Commons Standing Committee on Finance this week, testifying about the recently released quarterly Monetary Policy Report.

On Nov. 26, 2012, the Chancellor of the Exchequer George Osborne announced the appointment of Mr. Carney as the next Governor of the Bank of England, replacing Mervyn King. Mr. Carney will assume his new position on July 1, 2013, for what is officially an eight-year term, though he has already indicated that he will step down after five.

There’s little doubt that Mr. Carney earned the BoE appointment due to the worldwide perception that the BoC’s policy decisions during the Great Recession helped Canada navigate those troubled waters better than most of the developed world as well as the leadership role he assumed among G-20 central banks during and after the crisis.

It appears, however, that Mr. Carney is crossing the Atlantic in the nick of time, soon enough to preserve his reputation before the undoing of the “Canadian miracle” is made complete.

“The Great Recession” that afflicted most of the world was only mild by comparison in Canada, and the recovery for the Great White North was quick. Canada added approximately 900,000 jobs from August 2009 through February 2013, reducing the unemployment rate from 8.7 percent to 7.2 percent.

In 2009 Canada’s gross domestic product (GDP) contracted by 2.8 percent. During 2010, the first full year of recovery, it expanded by 3.2 percent, as aggressive policy action in the form of trillions of dollars in stimulus and sharp cuts to interest rates succeeded in breaking the fall.

In Canada, the federal and provincial governments spent about CAD60 billion to stimulate the economy, while Mr. Carney took the BoC’s benchmark interest rate to a record-low 0.25 percent.

These efforts mitigated much of the impact of slowing global growth. About 430,000 Canadians lost their jobs over the course of three quarters-plus from October 2008 through July 2009. But by August 2009 employment began rising again and has continued to build, reaching a peak in March 2012 with the addition of 78,000 jobs and highlighted too by an expectations-beating 50,000 new positions in February 2013.

Many governments spent on the wrong things, pushing stimulus through tax breaks or other short-term initiatives, or gave up too early, or simply didn’t spend enough to offset declines in private-sector spending. More should have been done in the US, for example, to effect mortgage relief for consumers and to rebuild crumbling infrastructure–investing in the country’s capital stock, with longer-term economic impacts–rather than rescuing troubled banks.

But Canada, too, relied to an unsettling extent on expanded consumer balance sheets to fuel its recovery. Canadians pushed household debt to a record high 152 percent of income by the end of 2012, funds they used mostly to buy homes. This led to a boom in real estate prices, even during a time of relatively high unemployment and fair-to-middling growth, even though it was better than most of the rest of the world.

But growth slowed to 2.6 percent in 2011 and to 1.8 percent in 2012. And last week, in the April edition of its World Economic Outlook (WEO), the International Monetary Fund (IMF) cut its forecast for Canadian GDP growth in 2013 to 1.5 percent. That’s down from a prior estimate, released in January, of 1.8 percent, which was down from 2.0 percent in the October 2012 WEO.

The IMF predicts Canadian GDP will pick up in 2014, to 2.4 percent. Unemployment will hit 7.3 percent this year before falling to 7.2 percent next year. The intergovernmental organization cited high household debt and a slowing housing market in support of its downward revision. It noted as well that business investment in and exports from Canada will benefit from a recovery in the US.

Anything that upsets the still-fragile, still-nascent and still-unsatisfying recovery in the US or that causes even more tumult in tumult-and-recession-ridden Europe–variables that would drag on commodity prices–will bring further downside for Canada, according the IMF.

The IMF issued its most recent WEO the day before Mr. Carney and the BoC held Canada’s benchmark interest rate at 1 percent, where it’s been since September 2010, making the current one the longest stretch without a change in half a century.

In his statement announcing the monetary policy decision, words that he echoed during his parliamentary testimony this week, Mr. Carney concluded that the 1 percent rate “will likely remain appropriate for a period of time,” after which borrowing costs will probably increase.

With continued slack in the Canadian economy, the muted outlook for inflation, and the constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required, consistent with achieving the 2 per cent inflation target.

Mr. Carney cited continued economic slack, a tame inflation outlook and “constructive evolution” of household sector imbalances–referring to slowing debt accumulation and a cooling in the housing market–for keeping the rate steady.

He maintained his generally hawkish position–indicating the BoC’s next move under his leadership would be to boost rates–by noting that after this “appropriate” period “some modest withdrawal will likely be required, consistent with achieving the 2 percent inflation target.”

The BoC’s April Monetary Policy Report concluded that “global economic activity is expected to grow modestly in 2013 before strengthening in 2014 and 2015.” A weak second half of 2012 will be followed by a gathering of momentum through 2013, though the Canadian economy won’t reach full capacity until mid-2015, “later than previously anticipated.”

The BoC forecast Canadian GDP growth of 1.5 percent in 2013, 2.8 percent in 2014 and 2.7 percent in 2015, with total and core inflation “to remain subdued in coming quarters” before gradually rising to 2 percent by mid-2015.

Mr. Carney has kept a rate hike on the table. His successor–who will be named shortly–probably won’t exercise the same tendency to announce his presence with authority by making an immediate rate move when he takes the reins at the BoC. Current Senior Deputy Governor Richard Tiffany Macklem, known as “Tiff,” has been described as the “runaway favorite” for the job.

Mr. Macklem was among a final group of candidates interviewed by the BoC’s board of directors in early April. By now the board has likely presented to Finance Minister Jim Flaherty its “short list,” probably in order of preference. Though Mr. Flaherty has said he intended to interview the final candidates himself, the final decision, according to Canadian law, is made by the entire federal cabinet.

Mr. Carney will be in charge for one more BoC monetary policy meeting, the decision from which will be announced on May 29. His successor will preside over the next meeting, which will conclude on July 17.

The BoC has already approached the “zero bound” in recent years. But, even if there’s further deterioration in the employment situation up north, 1 percent is an undeniably accommodative benchmark interest rate. Going lower from here would only encourage more balance-sheet expansion, which would, in turn, further expose Canada to external shocks to domestic growth.

Policymakers, including Mr. Carney and Finance Minister Jim Flaherty, have put the brakes on Canada’s housing market by regularly pointing out rising consumer debt levels and tightening mortgage-lending rules. Rather than allowing the country to plunge into a great recession driven by massive and immediate balance-sheet restructuring. Messrs. Carney and Flaherty are attempting to engineer a controlled slowdown.

The results will wear on folks who can’t find employment as companies horde cash to guard against slowing consumer spending. And Statistics Canada reported in early April that Canada shed more jobs in March than in any single month since February 2009, during the depths of the Great Recession.

But fiscal authorities, who must be more responsive to consumers/voters, have room to let “automatic stabilizers,” such as unemployment insurance, operate as they are intended. And, based on the response to the 2008-09 downturn, Prime Minister Stephen Harper is not totally ideologically averse to counter-cyclical federal stimulus efforts.

Canada, it should be remembered, has a bipartisan history of balancing budgets that was only interrupted by the recent recession. Once growth resumes a more normal course it’s reasonable to expect policymakers will do what they can to return to balance, it clearly being the case that investors appreciate the solid fundamentals underlying the Canadian economy.  

What’s been described as Canada’s economic “miracle” was never any such thing. The relative good health the country exhibited during and after the Great Recession was the result of difficult decisions made by policymakers across the ideological spectrum beginning in the early 1990s.

One of the long-term keys to unlocking Canadian growth is undoubtedly energy infrastructure, the types of projects, including TransCanada Corp’s (TSX: TRP, NYSE: TRP) Keystone XL pipeline and the Northern Gateway pipeline to British Columbia’s west coast, that will unlock crude from the Great White North for transportation to Gulf of Mexico refineries and for shipment to Asia.

In coming years, as the country rides out what will be a sluggish recovery from a devastating global crisis, Canada will have to emphasize increasing productivity to make its export sector more competitive. Policymakers must also diversify its trading partners, shifting east, away from its traditional routes and toward emerging economies.

Canada is still in an enviable position vis-à-vis the rest of the world. That its current rate of GDP growth now lags many of the countries it lapped in the immediate aftermath of the Great Recession is in fact testimony to a native conservatism that will make it a longer-term winner.