Monday, April 23, 2012 9:39 AM EDT
How ‘headwinds’ changed Carney’s tack on rate hikes
The use of the term “headwinds” in the Bank of Canada’s Monetary Policy Report (MPR) released last week deserves more attention than it got. The headwinds metaphor made its first appearance in last July’s MPR, where it was used to explain another interest rate decision that had caught many by surprise.
During the first half of 2011, the Bank of Canada’s measure of the ‘output gap’ – the difference between actual and potential GDP – had been reduced considerably from the levels it had reached during the recession, and core inflation was at the 2 per cent target. Ordinarily, the appropriate policy stance for these circumstances would have been one of modest stimulus, but the policy rate was still at the very low level of 1 per cent.
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Wednesday, April 18, 2012 11:53 AM EDT
Why on earth was Bay St. surprised by rate signals?
Expectations play a key role in monetary policy: one of the main objectives – if not the main objective – of the Bank of Canada’s 2 per cent inflation target was to anchor expectations of inflation, and this objective has largely been achieved: even when inflation fell below target during the worst of the recession, surveys of expectations for future inflation stayed steady at 2 per cent.
Being credible is one thing; being a crutch is another. Before the recession, private sector forecasters had come to rely heavily on the Bank of Canada’s guidance, to the point where the Bank felt obliged to remind them that they should spend more time looking at the data and less time reading Bank of Canada press releases.
Tuesday, April 10, 2012 10:12 AM EDT
Trade is not a zero-sum game
Arthur Donner and Doug Peter argued in Monday’s Globe and Mail that Canada’s current account deficit “is far more serious than the fiscal problems facing the federal government,” asserting that the CA deficit “represents a leakage of output, jobs and incomes to other countries.”
This is a popular view that is repeated frequently by public opinion leaders in Canada and elsewhere. It is also incorrect, as a brief perusal of any textbook discussion of international trade will confirm. These arguments are based on mercantilism, a theory that was debunked two centuries ago by David Ricardo.
Until interplanetary trade becomes a reality, the sum of all countries’ current account balances must be zero: Deficits in one country are offset by surpluses in another. The notion that a CA deficit is a “leakage of output” is derived from the broader misconception that international trade is a zero-sum game in which imports are losses to be avoided and exports are gains to be pursued.
This is exactly wrong. The reason why we engage in international trade is to obtain things more cheaply than we can produce them for ourselves. The real benefits from trade are imports; exports are the price we pay for those imports. Moreover, the gains are not zero-sum – both sides benefit.
In a world where capital is not free to cross borders, the current account will always be zero: Goods must be paid for with other goods. So the best way to look at Canada’s CA is not in terms of flows of goods, but in terms of flows of capital.
The current account represents the net change in Canada’s international investment position. A negative CA means that Canadian asset holdings abroad fell, foreign holdings in Canada increased, or some combination of the two. The CA can also be viewed as the net international transfer of savings, and is negative when foreigners shift more of their savings to Canada than Canadians send abroad.
A national accounting identity states that total investment expenditure must be financed by the sum of domestic and foreign savings. Noting that Canada has a current account deficit is the same thing as noting that investment expenditures are larger than domestic savings – the difference is made up by foreign investors.
Capital inflows are not always benign. Foreign savings helped fuel a U.S. housing bubble and contributed to the financial crisis there. Sudden and large inflows of “hot money” have often been destabilizing in countries whose financial markets are not sufficiently well-developed to absorb them. But if foreign savings serve to finance the creation of new productive capacity, then their effect is positive: Output, productivity and wages in Canada will increase.
The available evidence favours the good-news scenario. Investment grew more rapidly than GDP during the 2002-08 expansion, and expenditures on machinery and equipment have recovered their prerecession peak. The Bank of Canada’s recent Business Outlook Survey suggests that firms intend to invest more in the future.
So what would happen if the Bank of Canada decided to abandon its inflation target and work to depreciate the Canadian dollar? Canadian goods would become cheaper on world markets – and so would Canadian assets. The increase in foreign demand for Canadian goods would be accompanied by an increase in the foreign demand for Canadian assets.
The main obstacle to larger and potentially destabilizing inflows of foreign capital is the exchange rate; a high value of the Canadian dollar acts as a deterrent to foreign investors. A policy-engineered depreciation would accelerate capital inflows and could end up fuelling an asset price bubble.
Rebalancing the CA requires a combination of reducing investment, cutting back on consumer spending or increased government austerity. This may happen eventually, or maybe not – we’ve run a CA deficit for most of our history. But forcing a premature rebalancing will likely do more harm than good.
Stephen Gordon is a professor of economics at Laval University in Quebec City and a fellow of the Centre interuniversitaire sur le risque, les politiques économiques et l’emploi (CIRPÉE).
Friday, March 30, 2012 6:54 AM EDT
Wash, rinse, repeat: Next year’s budget won’t change
The main features of the expenditure side of next year’s 2013-14 federal budget should be fairly easy to predict:
- Transfers to persons will be about 4 per cent of GDP, and future projections will be consistent with this share.
- Transfers to other levels of government will be about 3.2 per cent of GDP, and future projections will also be consistent with this share.
- Direct program spending will be at or just above 6 per cent of GDP, and this share will be projected to decline throughout the forecast horizon.
The reason we can make these predictions with a certain amount of confidence is that these paths were set out by the Conservative government several years ago, and they have shown little sign of wanting to deviate from them.
Thursday, March 29, 2012 4:40 PM EDT
Access to foreign markets the best path to innovation
Expanded international trade and measures to encourage research and development (R&D) are two themes that are dealt with separately in the budget, but there are some important links between more openness to trade and innovation.
Research and development is costly, and much of Canada’s R&D policy framework is built around reducing those costs, most notably in the form of tax credits under the Scientific Research and Experimental Development (SR&ED) Program. Many observers have concluded that the SR&ED has been a costly disappointment: even though public spending under the SR&ED has been high by international standards, Canada still lags in international rankings of R&D and innovation.
Monday, March 26, 2012 4:19 PM EDT
The headline you’ll never see: Canadian investors fleece foreigners
Here is a headline that will never, ever run over a foreign takeover story: “Foreign buyers taken to cleaners by savvy Canadian investors.”
The reason you will never see that sort of a headline is that all stories in which foreigners buy Canadian-owned assets are based on the assumption that foreign investors are – yet again! – snapping up Canadian-owned assets on the cheap, and why oh why won’t Ottawa intervene and put a stop to it? The notion that Canadian investors are fully capable of assessing the value of their holdings and that they might earn a tidy profit in selling them never seems to make an appearance in these accounts.
Tuesday, March 20, 2012 6:48 AM EDT
How all Canadians benefit from Alberta’s oil wealth
The recent exchange between the premiers of Ontario and Alberta on the question of oil prices and the exchange rate raises an interesting question: if the government of Alberta chose to manage its natural resources in the best interests of Canadians outside Alberta, what would it do differently?
Alberta’s petroleum reserves constitute a huge store of wealth for its residents, akin to a winning lottery ticket. As everyone knows – or should know – the smart thing to do with a winning lottery ticket is to put the proceeds in the bank and to base spending on the investment income it generates, and not on the windfall itself. This is roughly the approach taken by Norway: much of its oil revenues are invested in a sovereign wealth fund whose purpose is to provide a flow of income to future generations of Norwegians after its oil reserves run out.
Monday, March 5, 2012 7:11 AM EST
Fixation with manufacturing is missing the big picture
The ‘Dutch disease’ story goes like this: an appreciating dollar increases the price of Canadian exports on world markets, and the resulting fall in the quantity demanded reduces export volumes as well as employment in export-oriented industries.
That’s good enough for all-too-many politicians and pundits: it sounds plausible, and -- perhaps more importantly -- it can be expressed in one sentence. But if you look more closely at this argument, it falls apart very quickly.
Thursday, March 8, 2012 9:09 AM EST
Canada chips away at the output gap
Probably the most striking feature of Friday’s national accounts release is not the headline number -- annualized growth of 1.8 per cent in the fourth quarter of 2011 -- so much as the upward revision in GDP estimates for the first three quarters of last year. Last November’s estimate for the third quarter was revised up my almost two-tenths of a percentage point, and the estimated annualized growth rate was revised from 3.5 to 4.2 per cent.
The Canadian recovery was knocked off track during the debt psychodramas in the U.S. and Europe during the middle part of 2011: GDP fell in the second quarter and the Bank of Canada’s estimate for the output gap widened. But these revised GDP number suggest that this derailment was short-lived: the output gap in the third quarter was approximately the same as it had been in the first quarter of 2011.
Friday, March 2, 2012 7:05 PM EST
Memo to Ontario's Dalton McGuinty: Strong dollar is good for Canada
Ontario Premier Dalton McGuinty has been reported as saying:
“[The high Canadian dollar] has knocked the wind out of Ontario exporters and manufacturing in particular… So if I had my preferences as to whether we had a rapidly growing oil and gas sector in the West or a lower dollar, I’ll tell you where I stand: with the lower dollar.”
There are several things wrong with this:
Stephen Gordon Contributors
Stephen Gordon
Stephen Gordon is a professor of economics at Laval University in Quebec City and a fellow of the Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE). He also maintains the economics blog Worthwhile Canadian Initiative and can be followed on Twitter.
