Remarks by Timothy Lane
Deputy Governor of the Bank of Canada
Ottawa Board of Trade
December 5, 2019
Ottawa, Ontario
Economic Progress Report: Charting
Our Own Course
Introduction
Good morning. It is a pleasure to be here to share my thoughts about the
Canadian economy and discuss the decision we announced yesterday to hold
I'd like to thank the Ottawa Board of Trade for the invitation.
interest rates steady.
It is news to no one that we are living in unsettled times. The world economy
continues to be buffeted by trade conflict, and relations between the United
States and China are on a roller coaster.
This enduring uncertainty has already done some damage. Global growth has
suffered. Because Canada is an open economy dependent on trade, our
economy has suffered as well. Commodity prices, which affect a big part of our
economy, have weakened over most of the year. Business investment has been
weighed down, and our exports have suffered because of softer global demand.
But Canada also has notable strengths, and inflation remains on target. Our
strong labour market points to sources of growth, such as computer system
design and other professional services, education, health care and financial
services. It is because of this strength amid the turmoil that we say Canada is
resilient, although it is not immune.
This resilience has helped the Bank of Canada chart its own course in monetary
policy. Many people wonder why we have held our key policy rate steady over
the past year while many other central banks have lowered their rates. The
comparison between Canada and the United States is front of mind. In 2019, the
US Federal Reserve cut its rate three times, partly as insurance against the
negative effects of the global environment. In Canada, we've kept our policy rate
unchanged since October 2018. That divergence is not as stark as it's
sometimes portrayed: when all is said and done, by this October the Bank of
Canada and the Fed ended up with the same policy rate. But it is sometimes
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believed we must do whatever the Fed does because our economy is so closely
tied to that of our largest trading partner. With that in mind, I'd like to take this
the path we've taken, not in terms of yesterday's
opportunity to explain only
decision but also more generally.
In my remarks, I will look back on these separate paths that Canada and the
United States have followed over the past several years. I will then review the
current situation and explain the rationale behind our policy interest rate decision
yesterday.
Long and winding roads
It's now been more than a decade since the
global financial crisis and the onset
of the Great Recession worldwide. That makes this a good time to briefly review
this history because it helps us understand where we are now.
Policy interest rates in Canada and the United States have followed distinct
tracks over the past 10 years, reflecting different macroeconomic forces.
Chart 1: Policy rates in Canada and the United States have followed
different tracks over the past 10 years
a. Level of the policy rates, daily data
%
6
5
4
3
2
1
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Canada United States
Sources: Federal Reserve Board via Haver Analytics and Bank of Canada Last observation: November 29, 2019
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b. Difference between the Canadian and US policy rates, daily data
Percentage points
2
1
0
-1
-2
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Sources: Federal Reserve Board via Haver Analytics and Bank of Canada
Last observation: November 29, 2019
Notably, the global financial crisis played out differently in the two countries.
Going back to 2009, the recessions in Canada and the United States were about
equally severe in terms of output loss, but for different reasons. The United
States experienced a home-grown financial crisis in which some major financial
others were threatened. Canada's financial system
institutions failed and many
was comparatively sound, but exports and commodity prices collapsed. Both
countries responded to their respective shocks by cutting interest rates as far as
they thought possible at the time. In addition, the Fed resorted to a large suite of
unconventional monetary policies. In Canada, we reinforced the low interest rate
we called the "conditional commitment"
using forward guidance-what to keep
our policy rate at the floor for at least another year unless inflation picked up. But
we went no further. In both countries-as in much of the world-fiscal policy
gave a major boost to demand during the recession.
After the rate cuts, Canada bounced back quickly. Exports and investment
rebounded, in part reflecting higher commodity prices. The United States had a
slower recovery. The Bank of Canada raised rates by 75 basis points to
1 percent in 2010. The Fed held rates near zero for more than five years.
Starting in 2010, as the recovery appeared to be underway, most major
economies began a course of fiscal consolidation. In Canada, the government
took steps to move the federal budget toward balance. The United States
implemented a policy of automatic spending cuts triggered by US budget law,
known as sequestration. With the benefit of hindsight, those moves toward
balanced budgets proved to be premature. The world was in for several more
years of lacklustre growth.
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Chart 2: The Canadian economy bounced back faster after the Great
Recession
Real GDP, index: 2009Q2 = 100, quarterly data
Index
120
115
110
105
100
95
2007 2008 2009 2010 2011 2012 2013 2014
Canada United States
Sources: Bureau of Economic Analysis via Haver Analytics, Statistics Canada and Bank of Canada calculations Last observation: 2014Q4
Competitiveness challenges facing Canadian exports also dampened business
As Canada's economy continued to fall
investment in the non-energy sector.
short of its potential, the Bank of Canada kept the policy rate at 1 percent.
Meanwhile, the US economy turned around, and in 2013 the Fed hinted at
tapering its purchase of financial assets.
Between 2014 and 2016, Canada had a major setback with the collapse in the
prices of oil and other commodities. We had a technical recession-two
consecutive quarters of negative growth-in 2015. The Bank of Canada
cushioned the blow by cutting policy rates twice, to 50 basis points. The
Canadian dollar depreciated by more than 20 percent against the US dollar. That
facilitated the adjustment to lower commodity prices. In addition, the federal
government introduced measures, including the Child Tax Benefit, that added
fiscal stimulus to the economy. In contrast, as US growth continued, the Fed
began to slowly normalize policy rates. Reflecting the more favourable US
economic situation, the US dollar appreciated. During this period, inflation ran
below target in both countries.
During 2017-18, economies worldwide expanded largely in sync. A major fiscal
Canada's
boost in the United States pushed that economy above potential.
economy reached close to potential, and our core inflation measures reached
target and stayed there.
This expansion allowed both the Bank of Canada and the Fed to raise rates
toward what is viewed as a neutral range. Still, Canada remained slightly behind
on the rate normalization, given the earlier setbacks to the economy.
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At this point, it is useful to note another major difference between the two
but Canada's
economies. The US housing bubble had burst in 2007-08, housing
market and mortgage debt continued to build in the decade after the global
financial crisis. Canadians borrowed heavily, and average house prices rose to
levels that were high by any metric. This was at least partly the legacy of low
interest rates, in a setting where households had room to borrow and commercial
banks remained very well-capitalized. These factors create vulnerabilities that
could amplify any negative shock to the economy.
Chart 3: Household debt as a share of income has continued to increase in
Canada, in contrast to the United States, where it has fallen
Index: 2000Q1 = 100, quarterly data
Index
180
160
140
120
100
80
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Ratio in Canada adjusted to US concepts Ratio in the United States
Sources: Federal Reserve Board via Haver Analytics, Statistics Canada and Bank of Canada calculations Last observation: 2019Q2
Between 2016 and 2018, a combination of policy measures affecting the housing
market were introduced. In addition to higher interest rates, macroprudential
measures-including the B-20 stress test-tightened mortgage lending. In a bid
to counter speculation, provincial and municipal governments targeted taxes at
non-resident investors. These measures led to moderation of the housing market
in many parts of Canada and to a drop in house prices in the most overheated
markets.
Starting in late 2018, the Canadian economy slowed once again. The cooling
housing market and adjustments in the energy sector related to transportation
capacity constraints and associated curtailments weighed on growth. Weak
business investment and exports in the sector contributed to the slowdown.
Trade conflicts were also a headwind. As an open economy, Canada is hurt by
the weaker foreign demand and lower commodity prices that come from trade
conflicts. The United States is less dependent on trade but, as the conflict has
escalated, has increasingly had the added drag of tariffs. Both countries-and
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indeed, the whole world-were adversely affected by the uncertainties around
trade conflicts.
On the monetary policy front, US inflation has been below target. The Fed has
cut interest rates three times during 2019. In contrast, the Bank of Canada has
not cut rates. In part, this is because inflation and its outlook remain on target,
and also because our policy rate was lower to begin with. Moreover, because
Canada already has high levels of household debt, lowering rates further could
make those vulnerabilities worse and amplify future shocks.
In sum, there is no reason for the Bank of Canada to move in step with the Fed.
On the contrary, the experience of the past decade shows that Canada and the
United States have followed different roads, reflecting differences in our
economic conditions. Canada does share many of the same macro fundamentals
as the United States. For long periods, the two economies are highly correlated,
so monetary policy can be very similar in those periods. But Canada is a more
open economy, with greater dependence on natural resource industries. For that
reason, we are more exposed to world events, both directly through demand for
our exports and indirectly through commodity prices. As a result, there have been
extended periods when our monetary policies have diverged. It is also because
of these differences that Canada benefits from a flexible exchange rate.
Chart 4: US inflation has been below target while Canadian inflation
remains close to target
Year-over-year percentage change, monthly data
%
3.0
2.5
2.0
1.5
1.0
0.5
2017 2018 2019
Range of core inflation measures in Canada*
US core personal consumption expenditure price index
Total Canadian consumer price index
* The measures are CPI-common, CPI-median and CPI-trim.
Sources: Bureau of Economic Analysis via Haver Analytics, Statistics Canada and Bank of Canada calculations Last observation: October 2019
Where are we now?
This brings us to the present. How is the economy evolving now, and what does
it mean for the outlook?
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Globally, economic growth has slowed significantly over the course of this year,
and it appears to be levelling off. The Bank still expects that it will edge higher
again in the period ahead.
The global slowdown partly reflects the fact that the US economy was boosted by
fiscal stimulus that has since been winding down. It also reflects a rebalancing of
the Chinese economy as authorities address high levels of corporate and
municipal debt. Against this backdrop, the global trade conflict has had a
meaningful negative effect on world trade and on business confidence and
investment. The damaging effects of trade conflict are only partly offset by easier
monetary policy.
Since our last full forecast presented in our October Monetary Policy Report
(MPR), the trade news has been mixed. The Canada-US-Mexico trade
agreement appears to be close to ratification. For most of the period, headlines
have suggested progress in the trade conflict between the United States and
China, although there continue to be many twists and turns. Financial markets,
already strongly supported by central bank actions, have been reacting to trade
news. Stock prices have moved close to record levels, some credit spreads have
narrowed, and market volatility has been low. At the same time, uncertainty is
likely to persist even if a deal is reached between the United States and China.
And that uncertainty is likely to have a lasting effect. Although a global recession
is not in our baseline forecast, questions remain about whether market pricing
fully reflects the risks inherent in the current global situation. Commodity prices
have been comparatively stable in the recent period. In this context, the
Canadian dollar has also been quite stable, keeping within a narrow range.
Turning to Canada, the Bank has been forecasting slower economic growth in
the second half of 2019 after a very strong second quarter. That is indeed how
the data are coming in. Economic growth in the third quarter was 1.3 percent, as
projected in the October MPR.
Underlying this slowdown in overall GDP growth was an outright decline in
exports. This has been driven by global weakness and trade uncertainty and by a
reversal of temporary factors that had previously boosted growth, in particular for
non-energy commodity exports. Furthermore, the pace of inventory accumulation
slowed, subtracting significantly from growth.
On the positive side, final domestic demand in Canada grew at quite a solid
pace. One thing that has surprised us was business investment. We were
expecting investment to decline in the second half of this year, but instead we
have seen solid growth. Moreover, data have been revised upward, revealing
that investment earlier this year was higher than previously reported.
Another area of strength has been housing, which is continuing to rebound.
We've seen most regions registering gains in resales and
housing starts
following a period of adjustment after the national and provincial policies had
worked their way through. Activity is also being boosted by strong growth in
employment and wages, strong immigration and low household borrowing costs,
which reflect the decline in global interest rates. House prices have also been
rising modestly and household borrowing has been picking up.
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Consumption spending has also been contributing to growth. As we mentioned in
October, the strong labour market, particularly in the service sector, has been
underpinning the economy. While employment levelled off in October, this comes
on the back of past strong gains. Moreover, wages-which could be seen as a
barometer of overall labour market conditions-are picking up further. Overall,
the data suggest that the labour market is continuing to tighten. Revised
historical data also indicate higher disposable incomes and more saving among
Canadian households than previously reported. Overall, recent information
financial situations and their future
augurs well for households' spending,
although consumer confidence has been softening.
Government spending is a mixed picture. While it has been supporting growth
recently, this support is expected to wane in 2020 as consolidation in Ontario and
Alberta takes hold and the recent strength in Quebec and British Columbia
normalizes. These dynamics were built into our October projection. On the
government's fiscal plans
federal side, the are pending.
The slowing of growth in Canada's economy has been concentrated in
goodsproducing industries, which were more heavily affected by the trade conflict and
by lower commodity prices. The service sector-which now accounts for about
70 percent of the economy-has continued to show solid growth for some time.
Our overall assessment is that the Canadian economy is near capacity.
However, this masks significant regional differences. Oil-producing regions
continue to go through a painful adjustment to lower oil prices and transportation
capacity constraints, and the labour market in Alberta has been weak.
Meanwhile, some other provinces are seeing strong growth in employment and
wages.
Finally, inflation remains broadly on target, with measures of core inflation
holding steady around 2 percent. Total consumer price index inflation was
1.9 percent in October and is expected to fluctuate around 2 percent. The
October reading was slightly higher than we anticipated, because of the impact of
higher airfares. Inflation is expected to rise temporarily above 2 percent in the
coming months, reflecting the impact of weak gasoline prices a year earlier. CPI
inflation should then return to target.
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Chart 5: The service sector continues to support economic growth
a. Contribution to annualized growth in GDP by industry
%
Percentage points
6 6
4 4
2 2
0 0
-2 -2
2017Q1 2017Q3 2018Q1 2018Q3 2019Q1 2019Q3
Services (right scale)
Construction (right scale)
Manufacturing (right scale)
Oil and gas extraction and supporting activities (right scale)
Other goods industries (right scale)
Growth in real GDP by industry, quarterly, at annual rates (left scale)
Sources: Statistics Canada Last observation: 2019Q3
b. Exports excluding energy, index: 2015Q4 = 100, quarterly data
Index
120
115
110
105
100
95
90
85
2013 2014 2015 2016 2017 2018 2019
Goods excluding energy Services
Sources: Statistics Canada and Bank of Canada calculations
Last observation: 2019Q3
Yesterday's decision
This takes us up to yesterday's monetary policy decision. Overall, the tone of
developments in recent weeks gives us more confidence in the outlook for
growth and inflation that we set out back in October. So, I and my colleagues on
Governing Council decided that the current setting of the policy interest rate
remains appropriate to keep inflation at our 2 percent target.
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In our discussion, we noted some initial signs that global economic growth is
beginning to level off, as expected. In particular, we noted a recent improvement
in global business investment and trade as well as stabilization in manufacturing
purchasing managers' indexes. We continue to expect that global growth will
edge higher over the next couple of years. We noted that central bank actions
have been supporting financial markets and that prices in many markets have
been reflecting an easing of concerns about the possibility of a global recession.
However, it is clear that trade conflicts remain the biggest risk to the Canadian
and global economies and the related uncertainty is continuing to dampen
exports and growth. We also noted that the Canadian dollar has been relatively
stable.
Turning to Canada, recent data show that the economy slowed sharply in the
third quarter, but they also support our forecast that this slowdown will be
temporary. Governing Council talked about the surprising strength of investment
in the quarter. The Bank will need to assess the extent to which this strength is
likely to be maintained as well as the implications for both economic growth and
potential output. We also discussed the strong housing markets and moderate
consumer spending seen during the third quarter. At the same time, consumer
credit growth has picked up. Given these developments, we will continue to
monitor how financial vulnerabilities evolve in the context of regulatory changes
designed to keep riskier lending in check.
Looking ahead, our interest rate decisions will be guided by our continuing
assessment of the economic impact of trade conflicts. We will also be watching
the sources of resilience in the Canadian economy-notably consumer spending
and housing activity. And we will take into account developments in fiscal policy
as we prepare to update our outlook in January.