With the Liberal election victory, Stephen Poloz's job just got easier. The Bank of Canada governor now has a government whose fiscal policies will lean with his current monetary policy, rather than against it. Indeed, the spending intentions of the newly elected Justin Trudeau Liberals may make another Bank of Canada interest-rate cut unnecessary.
The central bank will announce its latest interest-rate decision Wednesday morning, and it will almost certainly hold its key rate steady at 0.5 per cent, after two quarter-percentage-point cuts earlier in the year to help stimulate a sluggish, oil-shocked economy. Yet Monday's vote has changed the landscape for the central bank.
A Conservative government long focused on austerity has been replaced by a government committed to new spending, primarily on infrastructure, designed to stimulate the economy in both the shorter and longer term. Economists estimate that this injection from the government should boost economic growth by anywhere from 0.2 to 0.5 percentage points annually – not huge numbers, but maybe enough to get Canada over an important growth hump.
That will certainly be a welcome change for the Bank of Canada, which has been fighting an uphill battle to use its rate cuts to try to pick up the struggling economy, while Ottawa's spending restraint has been pushing downward. Indeed, some observers have wondered out loud whether the central bank was doing the Conservative government's dirty work for it, slashing rates so the government could avoid fiscal stimulus and continue to pursue balancing the budget in time for the election. While there's almost no chance there was any explicit agreement for the central bank to do this – the bank values its policy independence far too much – there's no doubt that the Conservatives' aversion to adjusting its balanced-budget plan forced the central bank to work at cross purposes to the government.
The Liberal plans, by contrast, should put them on the same page. And while this big injection of new government spending won't happen immediately – even with a ramped-up timetable, expect it to take six months or more before any shovels can break ground on new infrastructure projects under this plan – that dovetails with the timing of monetary policy. The central bank frequently reminds us that its rate changes have a horizon of six to eight quarters before their full impact is felt across the economy.
That means any rate actions considered today would be hitting their economic stride around the same time as the new government's infrastructure program does. The presence of the spending commitments may make another rate cut superfluous.
Don't expect the Bank of Canada to actually spell this out in its rate-setting announcement and quarterly Monetary Policy Report on Wednesday morning, though. Even if the central bank felt so inclined, there just isn't time. We're talking about a 30-plus-page document that must be thoroughly vetted, approved at the highest levels and printed in time for distribution on Wednesday morning; the text of the MPR is typically finalized a couple of days before release – not in time to incorporate the election results.
However, Mr. Poloz and his senior deputy, Carolyn Wilkins, will hold a news conference after the release of the rate announcement and MPR, and the election result and its policy implications are certain to come up.
Mr. Poloz's answer to such questions in the past has been to the effect that the Bank of Canada has no opinion on fiscal policy, be it stimulus or austerity. It merely takes its guidance from the government of the day on how much it intends to spend, calculates what that implies for government contribution to economic growth, and goes from there.
Under the spending projections from last spring's Conservative budget, the Bank of Canada had forecast that government would contribute just 0.2 percentage point to gross domestic product growth in 2016 and 2017. Under the proposed Liberal plan, those contributions to growth could easily more than double.
Wednesday's MPR won't have incorporated these changes in its economic projections, due to the aforementioned timing issues. But consider that private-sector forecasters project that Canada's economy will grow by about 2 per cent in each of 2016 and 2017 – a tepid pace that will barely make a dent in the economy's excess capacity (commonly referred to in central banking circles as the "output gap"). A recent International Monetary Fund forecast was even more pessimistic, pegging 2016 growth at just 1.7 per cent – a level at which the output gap would actually widen a bit, which would justify further rate cuts.
But increase that government contribution to GDP growth by 0.3 percentage point or so, and suddenly we're talking about growth that could make a much more serious dent in the output gap. The possibility of rate cuts fades. Indeed, the potential for rate increases starts appearing closer on the horizon.