Calm Amidst the Economic Storm – “Only in Canada, You Say?”

With outright panic sweeping global financial markets,  the relative calm among Canadian economic policy-makers seems increasingly strange.   Today’s timid quarter point interest rate cut by the Bank of Canada was hugely eclipsed by the US Federal Reserve’s three quarter point cut, rushed out the door  to try and soothe the savage beast known as Wall Street just before the much dreaded market opening.  The huge US fiscal deficit notwithstanding, everyone across the US political spectrum (not least George W Bush)  is calling for meaningful fiscal stimulus in the range of 1% of GDP. Meanwhile, almost no one in Canada seems prepared to challenge the seemingly axiomatatic case for a balanced federal Budget next month, even though Conservative tax cuts have eliminated the remaining fiscal surplus. The macro economic levers are being actively pushed, pulled and tweaked south of the border, but they are hardly even discussed here at home.

Sure, as folks like TD’s Don Drummond assure us, the Canadian economy is in relatively better shape than the US, which has now probably entered at least a  mild recession. But last month’s job report was troubling, and the growing Canada – US  interest rate differential is going to keep the Canadian dollar high moving forward,  deepening the manufacturing crisis. We risk a high dollar combined with some slowdown of the resource boom – look at the falling price of oil over the past couple of days.

Moreover,  to the considerable extent that the panic over a US recession is well-founded, we are crazy to ignore the very real consequences for Canada.  Growth in Canada may not subside as much as in the US, and unemployment may not rise by as much if our resource exports continue to be in high demand on global markets. But that’s a pretty big if. The scenario of Asian decoupling from a US recession seems to be evaporating before our eyes given the panic in Asian fiancial markets yesterday.  And, even if  Asia can grow amid a US recession , we are still talking about a serious worsening of the economic situation here at home because direct Canada-US linkages are still hugely important (think only of forestry, auto.)

So what should we be doing?

The Bank of Canada should fully match the US rate cut. If we don’t, we will be arresting a badly needed fall in the exchange rate. Also, we risk seeing a marked reduction in Canadian bank lending as our own banks weather the storm of the financial crisis. (Expect a lot more bad news on this front. Sub prime loans and asset backed commercial paper have already eroded the quality of Canadian bank assets. The downturn in the stock market is likely to turn a lot of loans to high leverage hedge funds into losses.)

And we should be seriously talking about a back-stop fiscal stimulus package to be inserted into the upcoming federal Budget -  major investments in  basic municipal infrastructure, public transit, energy conservation, and renewable energy to address key environmental issues while also building new industries and creating new jobs.  An affordable housing program could cushion against the coming downturn in the residential construction market.

Major projects will take some time to get off the ground. Let’s get on with the planning of what we need to do in any case, and figure out how a major public investment program should be financed  a bit down the road when the lay of the land is a bit clearer. We can plan to balance the books through a mild downturn, but should be prepared to run a modest deficit if  revenues don’t come in as anticipated.

The lion’s share of income gains over the past decade have gone to the top 1% while wages and the living standards of Canada’s working families have stagnated. A Budget which seriously addressed the possibility or prospect of a  recession would focus on improving our EI system in terms of access to benefits and the level of benefits, and provide income support for lower income working families who are emost likley to bear the brunt of layoffs and reduced hiring. We should raise refundable tax credits, starting with a significant increase to Canada Child Tax Benefit as called for and costed out by the Caledon Institute this week.

In short, things are looking bad. We should plan for the worst, rather than just hope it will all go away.

One comment

  • Hope this is not off topic, but I was wondering whether the relatively small exposure of Canadian banks to the sub-prime events would be much worse if the government had let them merge a year or two ago, so they could go and play with the big boys as they wanted to.

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