Mr Thiessen discusses the effect on the Canadian economy of recent global financial turbulence  (Central Bank Articles and Speeches, 4 May 1999)
Central bank: boc | Type: speech | Date: 1999-05-04

## Mr Thiessen discusses the effect on the Canadian economy of recent global financial turbulenRemarks by Gordon G Thiessen, Governor of the Bank of Canada, to the 'Chambre de commerce d la région sherbrookoise' in Sherbrooke, Quebec on 4 May 1999.

## Global financial turbulence and the Canadian economyThe world economy and Canada have had to navigate some difficult straits in the past c years.

But we have made it through.

And considering the tide from the Asian financial c washed around the world, the Canadian economy has coped better this time around than in theWith the clouds of international uncertainty gradually lifting, Canada's solid economic f are providing good reason to remain positive about the outlook for our economy.Today, I would like to talk about recent economic developments and the prospects for Cana since much of what has been happening here recently has been heavily influenced by external I would also like to discuss some of the measures the international community is contempl prevent, or at least reduce the severity of, any future crises.

## Recent developments in the Canadian economyThe financial crisis that began in Southeast Asia in mid-1997 turned out to be much more and serious than anyone had expected.

During 1998, the turmoil spread to Russia and Brazil, a great deal of nervousness and volatility in markets everywhere.

This led to large outflow from many emerging-market economies, rising interest rates, tighter credit conditions, and slowdown in economic growth worldwide.Canada has not been insulated from these forces.

Many of our industries, including those i have been hard hit.

The most immediate impact on our economy has been the lower foreign de for the key primary commodities we produce and a 20 per cent drop in their prices betw middle of 1997 and the end of 1998.

These developments were reflected in the value of our c which declined sharply against the U.S. dollar.As the turmoil in markets increased following the Russian debt moratorium last August, the Canada moved to head off signs of a potential loss of confidence in Canadian dollar invest raising the Bank Rate one full percentage point.

The confidence of households and busin Canada was also affected by market nervousness and volatility, and this dampened dom spending.

Consequently, the Canadian economy expanded by just under 3 per cent through (fourth quarter over fourth quarter) compared with over 4 per cent in 1997.Considering the seriousness of the external disturbances, this is not a bad economic outcom this, we can thank our sounder fiscal position and low and stable inflation, which have weather the international instability better this time around.

These same factors, coupled financial markets, have allowed the Bank to lower the Bank Rate four times since the autum reversing last August's increase), and to refocus attention on the medium-term objective o inflation within the 1 to 3 per cent target range.

Currently, inflation is just inside th range.

## The economic outlookAs I said before, the world economic horizon is now clearer.

Interest rate reductions aroun -- most recently across the euro area -- have helped to rebuild investor confidence and to financial markets.

This includes markets in the troubled Southeast Asian economies, whereis being made on structural reforms and the outlook for a turnaround this year and next has impr especially in South Korea, but also in Thailand and Malaysia.

There are also signs that the fin situation in Brazil, which looked precarious in late 1998, is now stabilizing with the adopt measures to address imbalances in the country' s fiscal and external accounts.What is less clear is the extent of short-term economic weakness one can expect in Latin Amer because of the difficulties in Brazil.There has also been a slowdown in the pace of economic expansion in Europe.

But easier monetar conditions -- that is, lower interest rates and the lower value of the euro -- should help offse the economic weakness there.

And these lower interest rates are a positive element for international economy as a whole.The main question mark in the outlook continues to be the Japanese economy, which has been i recession since late 1997.

Even if stimulative macroeconomic policies are pursued systematically, progress continues on banking sector reform, it is rather unlikely that there will be much of a r there before the year is out.In contrast, the U.S. economy continues to flourish, consistently outperforming expectations and no sign of inflationary pressures.

That economy ended 1998 on a much stronger note than had be expected.

And the momentum of U.S. economic activity in early 1999 is greater than most forecast had predicted.

From a Canadian perspective, this is the most positive element in the current ex economic environment, as anyone who sells to U.S. markets can confirm.Strong U.S. demand for Canadian products and the rebound from major labour disruptions in Canad led to renewed vigour in our economy in the fourth quarter of 1998 which, by all indications, c into early 1999.

And this has been accompanied by healthy employment growth.As we look ahead, steadier financial markets, employment gains, and accommodative monetary conditions should bolster spending by Canadian households and businesses.

All this, coupled w sustained U.S.

demand and our improved competitiveness, should continue to contribute to a expanding Canadian economy.Since world economic and financial conditions are still fragile and since the timing of a firm r in primary commodity markets remains uncertain, I cannot be more specific about how strong ou economy will be.

But we are now looking at a somewhat more positive scenario than seemed possibl last autumn -- both for the world economy and for Canada.

## What to do about future crisesAs much as we are all anxious to put this latest episode of global financial turbulence behin hope that in one respect, at least, we won' t soon forget it.

The fact that things are getti should not distract us from devising strategies to reduce the risks of similar crises in the fu should there be any, we need to be better prepared to handle them and to minimize their econo fallout.So what are some of the issues, and what is being done about them?It would be all too easy to blame globalization and unhindered, large, cross-border capital fl the recent financial problems, and to suggest that we retreat behind national borders and restrictions on the flow of capital.

But it would be unwise.

For even though capital flows sometimes be difficult to manage, especially for small countries, the benefits from access to a pool of world savings are substantial -- when those savings are used prudently and productively. we must do is find ways to minimize the risks, without surrendering the benefits.There are three main areas towards which international efforts are currently directed: s financial systems; ensuring that countries follow responsible macroeconomic and financial and developing effective processes for managing crises when they arise.Let's look at these three areas.

First, there is the need to encourage sound financia nationally and internationally.

Some of the things being addressed here are accounting and standards, supervisory and regulatory frameworks, and bankruptcy procedures.

Why do we ne strengthen these practices?Widely accepted accounting standards are the key to communicating reliable information company's financial health and to making its operations more transparent.

Disclosure of acc timely information strengthens confidence and helps markets to make more informed judgments the riskiness of investments.

Recall that one of the main problems behind the recent diffi the huge amounts of funds placed in some emerging markets in Asia by investment advisers industrial countries and by their clients, evidently without adequate information or apprec risks involved.

History shows than when concerns arise, lack of information causes inv expect the worst and run for cover.There is also a need to improve the effectiveness of regulation and supervision of banks financial institutions, especially in emerging-market economies.

Banks are important inter for moving funds around at home and abroad.

But they will perform this role most effecti soundly if they are properly supervised and if they have reason to control risk.

In coun banks have strong links to industry and/or to government, their ability to make object judgments may suffer.

And sometimes these relationships include provisions that protect ba failure but do not encourage prudent behaviour.Plans to improve global financial rules also involve strengthening bankruptcy procedur defined bankruptcy codes are important.

They can provide debtors and creditors with understanding of the rules for resolving defaults.

And they would enable the private busine continue to function even in the event of a financial crisis.So far, I have talked about institutional improvements that international bodies, like the Monetary Fund, are helping to design and put in place through a code of 'best practices'.

L turn to economic policies and their role in promoting greater financial stability.One important lesson we have learned from experience -- including our own in Canada -countries must, above all, follow sound and credible macroeconomic policies.

This means policy that avoids unsustainable public sector deficits and debts, and a monetary policy a and stable inflation.But the question of a country' s exchange rate policy is also very relevant.

Recent highlights the importance of ensuring that financial markets have the right incentives to decisions and to avoid excessive exposure to risks.

When a government pegs its exchange another currency, pledging to do whatever it takes to ensure that the peg holds, domestic investors tend to minimize the exchange rate risk, as long as things are going well.The problem with a fixed, but adjustable, exchange rate is that it does not guarantee tha will not decline in value.

Should it come under pressure, because it is fixed at a l inconsistent with changing fundamentals in the economy, and should markets begin to quest authorities' pledge to the peg, domestic and foreign investors would likely rush for triggering a crisis.

When you think of recent crises in Southeast Asia and in Brazil, the f strikes you is that they all occurred in countries with fixed exchange rates.I would argue that, in most of these cases, greater exchange rate flexibility would have hel make borrowers and lenders more aware of exchange rate risks.

And so I find it encouraging t some of the crisis-afflicted emerging countries have since moved towards more flexible exchan rates.Let me now say a word about the need to devise processes for the effective management an resolution of future crises, should they occur.

Right now, the International Monetary Fund is th provider of emergency assistance to a country that runs into financial difficulties, while its creditors are not always involved.

The main, and somewhat contentious, issue here is to ensure private lenders have the incentive to participate in crisis prevention and that they bear their of the financial burden of dealing with crises.Progress in this area has been slow, but a number of proposals are being examined that wo encourage debtor countries and their creditors to work out financial problems in a coopera manner.Let me conclude.

Thanks to a stronger foundation these days, the Canadian economy has thus f weathered the financial volatility and the global economic slowdown of the past couple of ye reasonably well.

And having started 1999 on a strong note, we are looking for sustained econo expansion this year.The situation in world financial markets has improved.

And the international community has be hard at work, seeking ways to strengthen the international financial architecture.

There is no simple solution to prevent crises.

Today, I have discussed some of the measures planned to provi degree of comfort.

None of them is dramatic, and much remains to be done.

But I believe that t changes should help reduce future risks.

Canada has a stake in building a stronger, more st international financial system, and strongly supports global initiatives designed to achieve this