The Bank of Canada and the Recovery
The Bank of Canadaâ€™s most recent Monetary Policy ReportÂ Â http://www.bankofcanada.ca/en/mpr/pdf/2010/mpr220410.pdf forecasts quite a strong short-term recovery. However, it is projected that growth will begin to taper off from the middle of this year and slow to just a 2% annual growth rate by mid 2011.
The recovery is being driven by government stimulus spending â€“ which remains significant through 2010 – by a strong housing market â€“ supported by low interest rates â€“ and by a recovery in resource prices and exports.
The Bank expects growth to slow as government stimulus spending is withdrawn, and as housing construction slows down. However, they expect a significant pick up in business investment in 2011. (Investment has been very weak and is now running about 20% below the pre recession level.)
The Bank also expects exports to continue to recover from todayâ€™s depressed levels. (Exports today are about 15% lower than in late 2007.) However, they do note that growth from this source will be limited because of the strength of the Canadian dollar, and a continued weak US economy.
The Bank may be over-estimating the ability of the economy to grow as government stimulus spending begins to dry up both here and in the US. Their forecasts for continued export growth and a pick up in business investment can be seen as quite optimistic given that there are very few signs of a significant recovery in the manufacturing and forestry sectors.
Even more contentiously. the Bank thinks we are now operating at just 2% below capacity and will be operating at “full capacity” by mid 2011.
This strikes me as singularly unlikely. Even if we get strong growth over the rest of this year, the national unemployment rate is likely to be still stuck well above 7% in mid 2011.Â As of April, even after a month of record job gains, there remained a big hole to fill compared to the pre recession job market. We are still down 368,000 permanent paid jobs, offset to a degree by gains in solo self-employment, temporary jobs and part-time jobs. That suggests significant slack in the job market, captured by the fact that the “real” unemployment rate is stillÂ almost 12% (11.8% in April 2010 compared to 8.9% in April, 2008.)
I am also a bit puzzled that the Bank expresses some concern about wage growth.Â Wages are, in fact,Â increasing at only 2% per year,Â exactly in line with the inflation target, meaning that there is no upward pressure on prices even at a time when productivity growth is very slow. (The April Labour Force survey showed that average hourly wages increased by 2% over the past year. Union wage settlements averaged 2.1% in the last quarter of 2009.)
The Bank is quite concerned about very slow productivity growth, which limits the ability of the economy to grow without inflation picking up.Â There are worse things than slow productivity growth in the early stages of a recovery, though we certainly need things to pick up in the medium term if we are to raise pay and living standards.
Two points are worth making.
First, slow productivity growth is mainly a result of very weak real business investment and an over-concentration ofÂ that investment in the primary resource sector. It is time to shift to direct support for new business investment, as opposed to costly, across the board corporate tax cuts which have had little or no impact. Such support is badly needed to create good , high productivity, well-paid jobs in manufacturing and the forest industry.
Second, the best single way to get strong productivity growth is to get unemployment down to low levels. Low unemployment will push employers to invest in new labour-saving equipment and to upgrade the skills of workers. Rather than see low unemployment as a potential source of inflation, the Bank should see a tight job market as a key driver of productivity.
I fear the Bank’s pessimism over potential growth will push them to raise interest rates prematurely, potentially choking off a still fragile recovery.