After growing at a red hot annualised rate of 5.8% in Q1 2010, Canada’s Economic growth has come down to just 2% in Q2, 2010. Canadian policymakers now need to look beyond the ‘short cuts’, be it interest rates or output, if they want the Economy to sustain its growth momentum.
Even net exports made a 4.5 percentage point drag on overall GDP growth. Result: In July, Canada’s trade deficit widened to $2.69 billion, the biggest gap since records began in 1971. What’s more? Net exports have not been a positive contributor to GDP growth since Q1 2009. While it does not appear that the drag from net exports will slow down anytime soon, what’s more confusing is the continuing soft inflation (at 1.7%) amid weak productivity growth (0.6% yoy as of August 2010), fast wage gains, and a closing output gap. So, with fragile economic recovery underway and inflation rate at the bottom of its target range, is it appropriate on the part of BoC to further increase the interest rates after already having raised them thrice in 2010?
There are still many who don’t see this as a threat to the sustainability of the Canadian economy in the long run. Jimmy Jean, the US based economist at Moody’s Economy.com tells B&E, “The housing retrenchment was long expected and has not been excessively severe, even showing signs of recent stabilisation. The cooling observed in consumer spending ties in closely with the housing slowdown, which again makes sense and is not overly worrying in light of still-healthy income growth.”
But then, income growth is likely to slow further considering the impact of the weak GDP growth on employment (unemployment rate is already at 8%) and, in fact, one can already see it happening. Second quarter GDP data already indicates a slowdown in consumer spending growth to 2.6% (yoy) from 4.3% in Q1 2010. Though BoC had not replied back to B&E’s queries till the time the magazine went to print, it, however, in its latest press release, accepts that the recovery in Canada will be slightly more gradual than it had projected in its July Monetary Policy Report.
No doubt, looking ahead, the IMF too expects Canada’s economic recovery to be among the strongest of the G-7 countries over the next two years. But, at the same time it should not forget that when an economy is not working normally (as is the case with Canada), one cannot rely on the ‘short cuts’, be it interest rates or output. In other words, policymakers should leave the overnight rates at 1% during their next policy decision on October 19, 2010. Rather, they now need to work towards developing models that have a better understanding of money and credit flows at a more disaggregated level and that include the key institutional features of banking and capital markets. If Canadian policymakers look only at interest rates, inflation, and output, they might miss out on the bubbles that perhaps might be in the making. If that happens, it could spell a disaster for the Canadian economy. Well, they say, it’s always better to be safe than sorry!
There are still many who don’t see this as a threat to the sustainability of the Canadian economy in the long run. Jimmy Jean, the US based economist at Moody’s Economy.com tells B&E, “The housing retrenchment was long expected and has not been excessively severe, even showing signs of recent stabilisation. The cooling observed in consumer spending ties in closely with the housing slowdown, which again makes sense and is not overly worrying in light of still-healthy income growth.”
But then, income growth is likely to slow further considering the impact of the weak GDP growth on employment (unemployment rate is already at 8%) and, in fact, one can already see it happening. Second quarter GDP data already indicates a slowdown in consumer spending growth to 2.6% (yoy) from 4.3% in Q1 2010. Though BoC had not replied back to B&E’s queries till the time the magazine went to print, it, however, in its latest press release, accepts that the recovery in Canada will be slightly more gradual than it had projected in its July Monetary Policy Report.
No doubt, looking ahead, the IMF too expects Canada’s economic recovery to be among the strongest of the G-7 countries over the next two years. But, at the same time it should not forget that when an economy is not working normally (as is the case with Canada), one cannot rely on the ‘short cuts’, be it interest rates or output. In other words, policymakers should leave the overnight rates at 1% during their next policy decision on October 19, 2010. Rather, they now need to work towards developing models that have a better understanding of money and credit flows at a more disaggregated level and that include the key institutional features of banking and capital markets. If Canadian policymakers look only at interest rates, inflation, and output, they might miss out on the bubbles that perhaps might be in the making. If that happens, it could spell a disaster for the Canadian economy. Well, they say, it’s always better to be safe than sorry!
Source : IIPM Editorial, 2012.
An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).
and Arindam Chaudhuri (Renowned Management Guru and Economist).
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