The Bank of Canada and the Recovery

The Bank of Canada’s most recent Monetary Policy Report 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 – which remains significant through 2010 – by a strong housing market – supported by low interest rates – 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The Bank expects growth to slow as government stimulus spending is withdrawn, and as housing construction slows down.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 today’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.  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 still  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.  Wages are, in fact,  increasing at only 2% per year,  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.  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 of  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.


  • duncan cameron

    Old habits die hard, and much of the Banks thinking is reminiscent of recent years. What they think does matter so this is an important update.
    On the low productivity/low (or nat resources heavy) business investment, we should be talking about creating new crown corps, a national transportation company for instance. Business has failed. Because there are profits without investment, I favour raising business taxation to the OECD average.
    The Bank have picked up the low productivity argument. Andrew Sharpe made an important presentation at the Bank conference honouring Dodge as outgoing Governor, and someone was listening.
    Reducing unemployment is the best strategy, agreed; reducing inequalities is another important theme.

  • Actually Andrew, I kind of agree with the bank that we are operating at 2% below capacity. This given the fact that we have suffered so much permanent removal of capital assets caused by the recession which say a one off in purging of capacity and a dollar that continues to flip around like a fish out of water.

    It is all up to business investment, we need the investment to surround those workers with a production process that can make a dent in the productivity that they speak of, without the business investment, labour productivity will continue to fall- but it has nothing to do with the qualitative aspect of the workers that the business press so wantonly wants to cycle through the discourse like a rat in a wheel.

  • “It is time to shift to direct support for new business investment”

    For example? Could you elaborate?

  • Hi Andrew,

    I’m in the process of reading “Whose Canada,” the CCPA volume.

    I enjoy the book for its predictive power, and for its timing. It really was published right on the precipice. The timing is very significant, in my view.

    My central critique of the volume thus far, and I have not completed reading the book, is its lack of “progressive internationalism,” to use your phrase (230).

    Sure, this is a book on continental integration, so it’s focus will be limited, but I still feel that international trends can, and must, be drawn.

    The level of interconnectivity is remarkable. I think about Premier Charest’s recent visit to India, for example, or Mark Carney’s concern for the Canadian economy because of potential impacts of the EU markets, prior to this Sunday’s agreement.

    I would suggest renaming the blog to Relentlessly International Progressive Economists, but the brand has already been taken (Review of International Political Economy).

    Thank you for a great book, and website! I’m learning an awful lot.

  • I think that the Bank is well aware that they have to be extremely careful, I don’t believe they’re going to do anything too hasty.

    As for the Canadian companies, they simply have to innovate, and the root of innovation must come in the form of increased labour productivity growth brought about by a strong capital investment track record. For example, TD Economics say that there is a direct correlation between generating higher output for each hour worked and a rising standard of living.

    We’re in the midst of a global economic recovery and the time is ideal for business investment and innovation, so I’m kind of optimistic.

  • One of the issues is that the B O C is banking on a strong housing sector throughout 2011, but as we have seen of late this is not the case. Personal gross income-to-home ratios are still massively inflated, so coupling this “real” assessment of housing paints a poorer picture on the recovery simply it is one of the pillar stones that such a recovery is resting on.

  • Actually, the global macroeconomic imbalances continue to create major risks to that outlook. And the existing bulky imbalances may re-emerge, with the attendant risk of disorderly adjustment.

  • With the economic recovery not in sight and forecast ed to probably linger on for another year or so, Provinces like Ontario & BC recently implemented HST,
    Hydro charges sky rocketed in the midst of recovery, who in the right mind like our Government to allow this to affect it’s citizen discouraging household spending, increasing the cost of Electricity hence creating less disposable income for it’s citizen. Yet, the Government is spending billions to upgrade it’s fighter jets for her defence, a wrong path taken and should be channel to it’s people in helping to create jobs and boost our disposable income.
    Where is the logic here? How will the recovery be smooth? It doesn’t make sense to increase houshold cost leaving no disposable income and greatly affected our seniors who are struggling on mere income from their pension.
    Someone, somewhere in POWER is truly looking after it’s pocket by implementing this ridiculous policy

  • Chiming in a decade later we can see the world and Canada is still addicted to low-interest rates. This will continue and many people will be priced out of buying a home because prices will inflate way beyond the “inflation rate” measured by BOC.

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