By Filza Maqsood
In the years following the financial crisis in 2008, Canada has fared relatively well compared to its peers. Nevertheless, the economy took a hit, especially as 45% of Canada’s economy relies on international exports. By the end of 2010, Canada was set on a path to recovery, with GDP and employment levels passing their 2008 peak. However, the good news was short lived, as exports in sectors other than oil and gas continued to lag. Recently, Bank of Canada Governor Stephen Poloz said “Canadians will have to get used to slower growth”. He likened the recession to economic “trauma”, suggesting a recovery process similar to that following a war. An analysis of previous recessions and recoveries by economists Reinhart and Rogoff show that recoveries from financial crises are especially painful. According to one of Canada’s leading economists, Christopher Ragan, “the sustained lack of confidence and dysfunction of credit markets can be remarkably damaging”.
Canada’s outlook for the next several years is tepid, sluggish growth, even as many analysts say the G7 did everything they could in 2008, acting both swiftly and aggressively to combat the recession. The first action taken by economies across the world was to reduce interest rates in the hopes of stimulating spending over savings. Governments also coordinated fiscal policy that included stimulus measures. Canada rolled the Economic Action Plan, which involved increased public spending and funding for infrastructure projects.
The traditional set of tools for stimulating an economy, from increasing consumer spending, private investment and net exports to regulating fiscal and monetary policy, have all been exhausted. For a variety of reasons, they have reached their limit and the national discussion needs to move from “how to stimulate the economy” to “how to mitigate the negative effects of slower growth”.
Canada’s main monetary policy tool is the interest rate, which has been frozen at 1.0% since 2010. Low interest rates should stimulate spending, which should in turn grow the economy and raise employment levels. However, in a recent study by the Bank of Canada, the private sector admitted factors other than interest rate were more important to their spending decisions. Firms always invest with the expectation of earning future sales and profits. Top economist Ragan explains “periods of uncertainty, and especially pessimism, about the domestic and global economies are … ideal for firms to reduce or delay investment plans while they wait and see how the economic environment evolves”. The current lack of confidence in the business climate has led investors to hoard their cash, regardless of low interest rates. In 2014 corporate cash reserves totaled CAN $630 billion, an increase from CAN $514 billion in early 2012.
Cutting interest rates further could exacerbate imbalances in the economy. Investors are more likely to engage in risky behavior and consumers would accumulate more debt. Already, household debt in Canada has reached record levels, and sectors including the housing market, have become inflated as a result. Housing prices across Canada have increased 20% since 2009 as households are eager to take on low interest debt to pay mortgages. When interest rates inevitably rise in the medium term, debt servicing costs will double. An increase in consumer spending could only be sustained with and unsustainable increase in debt. For these reasons both private investment and consumer spending cannot be expected to recover to pre-recession levels for several years.
“Periods of uncertainty, and especially pessimism, about the domestic and global economies are ideal for firms to reduce or delay investment plans”
Fiscal policy, or government spending, would also have limited effectiveness. Although Canada’s debt-to-GDP ratio is one of the lowest, in the coming decades the aging population and shrinking labour force will present a challenge to federal budgets. It would be very risky for the government to take on more debt to fund stimulus programs with the looming burden of billions in unfunded liabilities.
The final component of the economy that could stimulate growth is the country’s exports. However, with only modest economic recoveries taking place in the U.S, EU and elsewhere, exports are still $130 billion below their expected level given historical data from recoveries. A study by the Bank of Canada in 2013 found that the trade relationship between other countries and Canada has weakened, so even a full external recovery would not bring Canada to its potential.
The government needs to acknowledge the situation and minimize the burden to those most affected. Of course, it should continue to tax and spend wisely, but know that the effects of any programs or policy it implements will be blunted until the confidence of consumers and businesses returns. By Filza Maqsood
