Bank of Canada Governor Mark Carney said this week that Canada's economic prospects have deteriorated in the past month, and the central bank may further cut interest rates to stimulate growth.
In the Speech from the Throne Wednesday, Prime Minister Stephen Harper's re-elected Conservative government made the slowing economy the prime focus of the new session of Parliament.
As other economies have slipped into recession, the Canadian economy - so far - has weathered the global credit crisis and economic downturn better than many. However, it is a matter of debate as to how well - and how long - Canada can withstand the recessionary forces that are buffeting its major trading partners and wreaking havoc with commodities, foreign exchange and equities markets.
Bank of Montreal senior economist Sal Guatieri is was online earlier to take questions on the Throne Speech, the collapse in commodity prices, the lower loonie, the Bank of Canada's interest rate policy - and where the Canadian economy may be headed from here.
Your questions, and his answers, appear at the bottom of this page.
Mr. Guatieri has more than 15 years' experience as a macro economist and financial markets forecaster. Since joining Bank of Montreal's financial group in 1994, his main responsibilities have included analyzing and forecasting the Canadian and U.S. economies, interest rates and exchange rates. He contributes to the bank's various publications and gives economic presentations to BMO clients. He is a regular commentator on the economy and markets, and provides high-frequency economic analyses to capital markets traders and clients.
Before joining BMO, Mr. Guatieri worked as an economist at the Bank of Canada, contributing to the BoC's quarterly economic projections and analyzing foreign exchange markets.
Mr. Guatieri earned a Masters degree in economics from Queen's University in 1990. He has been secretary for the Toronto Association for Business Economists since 2000.
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Virginia Galt, globeandmail.com: Good afternoon, Mr. Guatieri, and thanks so much for joining us today. There's been no shortage of economic news this week. Bank of Canada Governor Mark Carney is predicting further deterioration in the economy, the Big Three automakers are fighting for survival, and the loonie is on a downward projectory again this week.
Where do you want to start?
Sal Guatieri: The economy is in rough shape, and it's going to get worse before it gets better.
Canadian GDP will likely contract for several quarters. The global recession is sapping demand for our exports and commodities. The U.S. economy is in a deep downturn comparable to that of the early 1980s. Our housing market is cooling fast in the face of reduced affordability and plunging consumer confidence.
We look for a moderate recession in Canada to last through the first half of 2009, sending the unemployment one percentage point higher to above 7 per cent>
A gradual, modest recovery is expected in the second half of next year in response to low interest rates and some pick-up in U.S. demand. But this depends critically on an easing in the global credit crisis, which in turn depends on some stabilization of U.S. house prices.
CM, London, Ont: It looks like we are getting awfully close to some serious deflation.
If that is the case, what will the Band of Canada do about that and how effective will their measures be?
Mr. Guatieri: CM, given the collapse in commodity prices and the looming recession, we expect inflation to drop to about 1 per cent by next summer.
Still, the risk of sustained deflation (steadily falling prices) is pretty small, since the BoC has a sure-fire remedy: Print tons of money and flood the economy with it.
The BoC can use the new money to expand banking reserves and purchase government bonds. Overnight lending rates would fall to zero, and longer-term rates would decline too.
One way or another, the new money would start flowing through the economy, stimulating demand and putting a floor on price declines. If the BoC doesn't mop up the excess liquidity when the economy recovers, then inflation would be a problem. But the BoC has a fair record of keeping inflation low and steady since the establishment of its inflation targets in the early 90s.
B. Hind, Toronto: Did the big Canadian Banks see the present economic situation coming before or by the summer of 2007? If so, why did they not alert the public at that time?
The reason I ask is that, with hindsight, there were three things in my dealings with banks that are now curious to me.
The first sign was my margin account in Feb 2007. All of a sudden my broker (big bank) did not want me to margin $20K for a RRSP contribution when I had $400K with them.
Next, in July 2007 what should have been a slam dunk $50K line of credit for my small business was met with a firm "No" and averted eyes and a quick change of subject by my friendly (heretofore) banker.
Finally, a bank that I am indirectly a vendor to started "cost containment" in the summer of 2007. ( I found out in January of 2008). Ouch to the vendors.
Curious.
Mr. Guatieri: When the credit crunch struck in the summer of 2007, most analysts warned about the potential negative consequences for the economy.
However, very few analysts anticipated just how bad the financial crisis would get. What we are seeing is unprecedented in our lifetimes, making the historical economic playbook virtually useless as a guide to forecasting.
Virginia Galt, globeandmail.com: To what extent will Canada benefit from the stimulus packages around the globe? Does that take the pressure off the government to enact stimulus of its own?
The IMF says countries should put together fiscal stimulus worth 2 per cent of their GDP. Ottawa disagrees because of its obsession with staying (nearly) out of deficit. What do you think? Would a big stimulus package do much for us?
Mr. Guatieri: Canada will benefit from other countries' fiscal stimulus packages indirectly, via support for our exports and commodities.
A probable large fiscal plan in the U.S. early next year will go some ways to supporting a U.S. economic recovery. A large fiscal package from the Canadian government would provide welcome, direct support to the economy.
Given the dire economic situation, voters would forgive the government for running a temporary deficit. The government can borrow at historically low interest rates today.
A focus on infrastructure projects would preserve some of the jobs that will be lost in coming months, and boost long-term productivity.
Virginia Galt, globeandmail.com: What happened in October that has prompted such a quick downturn of expectations? We saw some strongish data for Canada in September, and it looked as if Canada might avoid a recession.
Mr. Guatieri: The credit crunch morphed into a credit crisis in mid-September when Lehman Brothers failed and the U.S. government was forced to save the large insurer AIG.
Lehman was one of the largest issuers of commercial paper, and its failure caused investors to pull their funds out of money market funds. Even highly-rated U.S. firms had trouble issuing paper in October.
AIG, a large seller of credit default swaps, raised concerns about counterparty risk, causing investors to think twice (or thrice) before parting with their funds.
As credit tightened further, consumers and businesses retrenched, sending the U.S. economy into a deep downturn.
This, along with worsening economic news abroad, raised fears of a deep global recession, sending stock markets plunging. Canada's economy has fared not too badly so far, but it probably can't hold out much longer.
Patrick The Christian Warrior, Canada: Prime Minister Stephen Harper said after a G20 meeting of leaders from the world's biggest economies last weekend that Canada would join in any major international spending effort to stimulate the economy. However, it will not happen now, Mr. Flaherty said.
This is a perilous time for the world, Mr. Flaherty. There is no time to waste. World leaders must act now. The economy does not function according to theories that many economists would have suggested.
The economy, not the market, is much more influenced by human emotions of fear and greed than science. If people start to believe there is a major depression coming, people would retreat into a survival mode and stop spending and investing all together, and the economy will go into a deep depression. It's a self-fulfilling prophesy.
It's sad the US President-elect Obama does not take office until Jan 20/09. In the interim, the world is in a leaderless vacuum period, which is a period of uncertainties, and markets hate uncertainties.
The recent G20 meeting is just a waste of time. The world needs a leader that can rally the support of the people worldwide into decisive actions, regardless of the effectiveness of the actions, it's the decisiveness that will give people hope, and hope will get people to spend and invest again.
We must stop the bleeding in the markets NOW before fear sets in and completely takes over. A suggestion: promote blue-chip companies to aggressively buy back their shares when stock price to book value multiple is less than 1.2 to 1.5, or at a screaming value by historical standards. If the companies don't have cash, provide emergency loans.
This action will tell the world that the companies are confident of their future and are willing to put up. Market values are based on market closing prices, the more they erode, the more chaotic our world will become.
Mr. Harper, coordinate this buy-back program among the G20 countries, the effects will be immediate. Buy us time.
Your thoughts, Mr. Guatieri?
Mr. Guatieri: I would agree that we are running out of time, and something needs to be done before we "scare ourselves" into a deeper recession.
Fiscal stimulus is needed, the sooner the better.
I think infrastructure spending is the way to go to support a recovery. Once blue-chip companies see the light at the end of the economic tunnel, they (and other investors) will buy back their undervalued shares.
John from Toronto: So far, this crisis has turned out to be far worse than anyone had projected.
What's to prevent things from spiralling down into another Depression?
Mr. Guatieri: John, aggressive policy actions on both the monetary and fiscal side should prevent another Depression.
A lot of policy mistakes have to be made to cause a Depression (like raising taxes, tightening monetary policy, and erecting trade barriers). Our social safety net also mitigates the risk.
In the 1930s, if you lost your job, you lost your income and stopped spending, causing your neighbour to lose his job, and so on.
That chain reaction of job losses is muted by our EI and welfare programs today. While I wouldn't rule out a long, deep recession, the odds of another Depression are pretty small.
John Thompson, Whitby, Canada: With all the talk around the 'Big Three' and them needing a bailout, what would the effects on the Canadian economy be as a whole should one or more of them go under?
Secondly if we do go into a recession how long do you think it will last?
Mr. Guatieri: John, I can't quantify the impact on our economy, but it's clear the impact would be sizeable, especially in Ontario.
Since the economy is already on the ropes, the loss of one or more of the Big-3 makers could seriously prolong the expected recession, especially if it worsens the U.S. downturn.
The further hit to Canadian consumer confidence and housing markets could be severe. Assuming the Big-3 do survive, we expect a mild recession to last until next fall, but all bets would be off if they don't make it.
Lorrie Naylor, Stratford, Canada: Dear Mr.Guatieri, My Mrs. and I have always taken, and prefer, a long-term view on investments.
We are invested: income+cash vs. equity 2:1; CDN Equity to US equity, also: 2:1 (a trivial statistical residual in 'international' equity).
Now, in normal conditions, a 32 per cent equity position would be regarded 'very conservative' long-term. These are not 'normal' times, however. This morning -- notwithstanding the 700B US bail-out, the UK bank nationalization, the G20 summit and commitment from central bankers to a coordinated international response -- Asian markets collapsed.
And, notwithstanding our country's strong fundamentals, the relative stability of our banks, the immensity of our oil sands in an oil-parched world, all our gold and potash, or the fact that we're awash in water, the TSX dropped this morning to lows it hasn't seen since 2003 (8000), then bounced back, only just, and gasping for life.
Our investment advisers, who are your counterparts at another major CDN bank btw, 'fessed up' that the very best minds are unsure when equity markets will bottom (included on the list of 'best minds' were Mssrs. Bernanke and Greenspan). There do exist good indicators that reasonable minds could point to and take hope (for example, Fed Chair Bernanke's doctoral thesis was on 'what to do to avoid another Great Depression').
Yet, the markets do not seem reasonable; 'self-fulfilling prophets of doom' appears an apt label. So, my question: where is there virtue to be found in maintaining any kind of an equity position whatsoever, today, rather than waiting until it is obvious that there has been a turnaround financially, as well as economically? Two or three years out, say, when good information combined with rationality ultimately prevail?
Mr. Guatieri: Lorrie, all I can add is that if you wait until it is obvious that the financial/economic crisis is over, you will likely miss a good chunk of the next bull market (whenever that is).
One rule of thumb to follow is: If you believe your equity holdings are undervalued (and are being thrown out with the bathwater), then you should hold for the long run. If not, then you should sell.
Garlick Toast, Canada: I don't understand how collapsing commodity prices will result in deflation for Canada since 3/4 of them are exported. On the other hand, I think stagflation is a very real possibility.
Sal Guatieri: I think both deflation and surging inflation are fairly low probability events, given that our central bank is targeting 2 per cent inflation and has all the means to achieve its target.
The "stag" part though is probably a done deal, at least until next fall.
Virginia Galt, globeandmail.com: Thanks so much for taking questions from our (worried) readers today about the economy. Do you have any closing thoughts?
Mr. Guatieri: Given all the doom and gloom out their (deservedly so), I would like to say one last thing: Recessions are normal, they occur about every eight years or so.
Canada is well positioned to withstand the current one, especially with interest rates so low and heading lower.