Benchmarking the recession: longer and deeper

Over at Worthwhile Canadian Initiative, Stephen has posted a nice graph comparing the average projections from the private sector (as compiled by the Parliamentary Budget Officer) and the Bank of Canada with the paths of the last two recessions. He is poking a hole in a story that there is a gap between the more optimistic Bank view and the private sector forecasters.

In fact, the Bank and private sector forecasters have been roughly on the same page for the past couple years. That is, totally delusional about the future prospects of the Canadian economy given some pretty obvious signs. It is likely that the Canadian recession will have begun officially in the fourth quarter of 2008 after flatlining for the previous three quarters. And yet a year ago neither the Bank nor the private sector forecasters saw a recession coming at all, and while there were some downgrades as the year progressed, the view that Canada would not experience a recession persisted right into the same fourth quarter. In other words, neither the Bank nor the private sector projected rain until the drops started to fall on our heads.

So why should we trust their opinions looking forward? We should not. The Bank’s forecasts have no credibility as they are in the position of trying to restore confidence and have already used up almost all of their conventional ammo (through interest rate cuts). They are thus biased towards a more optimistic forecast. The other private sector forecasters are just hopeless. Those who are calling for a return to our previous growth path in just over a year owe us a good explanation of what is going to drive that resurgence.

To me, Stephen’s graph lends support to the view, expressed by many on this blog, that we are in for a rougher ride that will probably last through 2010, with a period of stagnation or jobless growth following that for a couple years. Even if we just assume that we will follow the average trajectory of the past two recession the outlook is pretty grim, and this recession may even be worse. The economy has begun downward spiral with rising unemployment fueling lower demand, which will lead to more unemployment. All on top of a major shift in psychology – an increase in liquidity preference as highly indebted households retrench on spending and businesses retrench on making new investments. The corporate sector has been in a net saving position in recent years, so the challenge is less about access to credit as it is the context of weakening demand.

The mainstream diagnosis is that this is all due to a credit crunch in the financial markets resulting from US sub-prime mortgages. But that is more the symptom, and the data point to continued increases in bank lending. The real underlying driver is the collapse of the housing bubble writ large, with sub-prime mortgages being the tip of a very large iceberg. Housing resale prices will continue to fall this year and maybe next year, with depressed activity undercutting the total volume of sales and more importantly housing starts. In BC (where the bubble was arguably most acute) it is estimated that housing starts will be 45% lower in 2009, a huge hit for an economy that has boomed with residential construction in recent years (equivalent to about 3.5 percentage points of GDP). Add in the popping of bubbles in stocks and commodity prices, and an overall context of weak US demand, and the picture is not pretty for the Canadian economy. The Obama stimulus package squanders one-third on tax cuts, and another chunk is funding for state governments to avert their cutting spending to balance their budgets so it is not really stimulus.

The outcome depends greatly on the response of governments, with much of the action so far on the monetary policy front, and only more recently fiscal policy. But the perceptions of what is causing the recession and its likely duration have meant a much weaker fiscal response than is necessary. It is notable that there is a big difference in the fiscal/monetary policy mix compared to the previous recessions in the graph, however, though I think the fiscal taps are just starting as provincial budgets get tabled, and another round of federal stimulus will come next year.

One major area of concern is around automatic stabilizers, as the federal budget did essentially nothing to shore up the EI system. The restructuring of EI goes back to Paul Martin and the 1995 budget, and the new system has not had to deal with a recession yet. Two week waits, high number of weeks worked to be eligible, 55% replacement rate (with a max of $435 per week), and no coverage of the self-employed all undermine the effectiveness of EI. Roughly the same can be said of provincial social assistance programs, as benefits are too low and many hurdles have been made to access them.


  • “The corporate sector has been in a net saving position in recent years, so the challenge is less about access to credit as it is the context of weakening demand.”

    Has there been past discussion/evidence of this statement? I’m not challenging your claim, though I will admit to being a little skeptical; I would like to go further into the data on this point.

  • I really appreciate the quick link on that, Marc. Is there a sense to what degree the remarkable boost in the corporate lending/borrowing rate may be due to a rise in commodity prices in the post-’99 period and, if so, could that lead to an unbalanced corporate picture in this kind of broad picture analysis?

    I suppose I am still skeptical that the corporate sector overall have been net lenders for the past 9 or so years. Where is all that money coming from? All from household borrowing?

  • I appreciate this post which I think is right on the money. Do we not have a basic configuration of purchasing power being poorly distributed and creating problems on the demand side, and over-production on the supply side. So long as the people who want to spend do not have the money, and the people who have the money do want to spend, we are looking at trouble. As well, could it be that the green shift is taking place, and that it takes the form of people not buying cars?

  • rumor, Marc: I’m not sure when you are talking about stocks, and when you are talking about flows (and it’s possible you may be misunderstanding each other as well).

    Here’s my take: on stocks. Net external debt, very small, so roughly speaking, “we do owe it to ourselves”. Government: net debtor. Business sector: net debtor. Household sector: net creditor. Government and businesses owe money to Canadian households.

    But Marc is talking not about stocks, but about flows, right? About how these stocks of assets and liabilities have been changing over time, with government and business liabilities falling, and so household net assets (the other side of the coin) falling too?

    Going slightly off topic; I have come to the conclusion that these aggregated, “average household”, representative agent” discussions of debt are VERY misleading. OK, when we aggregate we always lose something, but when we aggregate over debts we lose everything. Since, in aggregate, “we owe it to ourselves” the representative or average agent owes nothing on net, and so cannot (logically) default.

    I had a mini-rant on this topic over at Worthwhile Canadian Initiative a month or two back. Oooh! I’ve managed to use Google on WCI! I am proud of myself!

  • Optimismis apparently the only involvement the federal tories are willing to put policy forth on this fight against deflationary spirals. (oh and misguided Made in USA protectionist rants by Stockwell Day)

    The Onatrio governement doesn’t seem to be doing much better, with it’s business backed report that was released yesterday providing the blueprints for somekind of strange, uni-dimensional focus on developing a “creative economy”. What the hell?

    At least stick to the prevailing fantasy would you guys, its called the knowledge economy, with knowledge and information workers. I guess some new utopia was needed by the vanguard post modernist business leaders of Ontario.

    Why is it in these “visionary” documents do we have to be so focused on something new. The document portrays the traditional, out with manufacturing on with the new economy stuff.

    Again we have the business leaders telling us all that their is no space left in our economy for manufacturing. It the same tired dispensing that they tried in the 80’s and the early 90’s. Grow the new economy as the old industrial economy is beyond our capabilities.

    Well let me say this, if the writers of this report are the leaders we are looking toward for solutions, then longer and deeper will for sure be our reality.

    Look at the employment data for the 80’s and 90’s, maunfacturing in both episodes of required were driven by huge gains in manufacturing .

    The point that is lost on these writiers is we need a multi tiered objective. We need a broad mix of renewal and growth strategies. But we need to be focused within these braod industries. We need a mix of manufacturing, knowledge intensive, creative, resource extraction, green focused and service delivery type renewal. Each area has a strong role to play withn the rebuilding of our economy. Some are integrated upstream, some downstream and some are parallel.

    The bottom line is we need to quite writing off important sectors and pretending like we did in the 90’s that some kind of wonderful knowledge economy now the “creative economy” is the panacea.

    I am not saying these economic sectors are not important, but they are part of a large picture. The myths and the short sighted ess of vision must become a lot more inclusive.

    Maybe premier Dalton had better invite some extra guests next time.


  • Fair comment, Nick! Thank you – your reply made me think about the data more carefully. Flows are definitely our concern here, and what the chart deals with, but it’s good to make the distinction clear.

    I note that the changes over the years between the three different sector ratios more or less balance out (what’s $20 billion here or there? Not even real money, right?), so maybe it’s a just a matter of a switch in direction? Perhaps it’s just household (and non-resident to a smaller degree) borrowing that’s financing the reflective increase in corporate lending (and government to a smaller degree). I guess that makes sense, given that the number are roughly equivalent on the up/down sides?

  • Right, going back to what was said in the post that Marc linked – the flows have to balance to zero.

  • Nice set of comments, all. I’m glad rumor made me go back to Wenonah’s post on sectoral flows, and Nick for adding the important context around stocks/flows and who owes who what.

    It is a useful exercise to take stock of these aggregates (or would that be flows …) and how much has changed during the recent expansion. Wenonah will be posting the 2008 numbers soon. I suspect we are going to see those lines converge, as households retrench on spending, governments go into deficit (and in doing so provide the very assets households want to purchase), corporate profits shrink, and our external balance diminishes.

    As Nick points out, the distribution of household debt matters. Households have been dis-saving in favour of capital gains on housing and stocks, but not equally so. The distribution of debt matters also in relation to falling asset prices, and comes against a backdrop of incomes that have been increasingly unequal, and ultimately back to those corporate profits, which are even more unequally distributed.

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