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economy lab

U.S. shoppers at a Target store in Chicago last Novemeber. For the first time in years, the economic news out of the U.S. is encouraging.

In a recent post, I wondered if the timing is right for a federal austerity budget. Recent developments in the United States have provided support for the 'austerity now' camp.

For the first time in years, the economic news out of the U.S. is encouraging: a strong jobs report for January, a continuing fall in the number of initial claims for unemployment benefits, and even signs that its housing market may begin to revive in the near future. It may appear unseemly parochial to wonder what a U.S. recovery means for Canada, but that is the question that matters for Canadian policy making.

The recent recession should put to rest sayings such as "when the U.S. economy sneezes, the Canadian economy catches cold" to rest. The Canadian recession began almost a year after the U.S.' did, was much less severe, and was over much more quickly. Nor was this an exceptional episode: the effect of a U.S. recession on Canada is much smaller than what is generally supposed.

The obverse side of this statement is that a strong U.S. recovery doesn't guarantee strong economic growth in Canada. But it may be enough to offset the effects of an austerity program that will be much less austere than that implemented by the Chrétien Liberal government. In 1995, the federal structural deficit was on the order of four per cent of GDP, as opposed to 1 per cent now. Even if the Conservatives implement federal public-sector cuts similar in magnitude to those of the mid-1990s, transfers to provinces and individuals are to be spared.

And although the Bank of Canada can't lower interest rates much further in order to offset the effects of a fiscal contraction, foreign exchange markets can provide monetary accommodation in the form of a depreciation of the Canadian dollar. The austerity of the 1990s was greatly offset by a lower Canadian dollar, and it's not unreasonable to think that a similar combination of Canadian austerity and U.S. expansion would lead to another depreciation that would cushion the effects of federal budget cuts.

The Conservatives have decided that the political timing is right for austerity. The latest U.S. data have made it easier to believe that the economic timing may also be right.

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