Mark Carney: Employment in a modest recovery
Remarks by Mr Mark Carney, Governor of the Bank of Canada, to the Windsor-Essex
Regional Chamber of Commerce, Windsor, Ontario, 30 September 2010.
* * *
It is a pleasure to be here to discuss current economic conditions with the Windsor-Essex
Regional Chamber of Commerce. I look forward to this opportunity to hear insights directly
from business leaders.
Insights from financial markets are somewhat fleeting at the moment. A broad range of asset
prices from the Canadian dollar to S&P500 futures to European sovereign spreads are
unusually correlated and volatile (Appendix, Every morning by looking at any one
Chart 1).
of these variables you can readily tell whether markets are in a risk-on or risk-off mode.
In the current environment, the macro dominates the idiosyncratic. The good and bad moves
you make as business people will, for the moment, go largely unrewarded or unpunished.
What matters most is the daily perception of the answers to three very big questions:

Will the U.S. recovery falter under the weight of balance-sheet repair and slow
employment growth?

Can the rest of the world sustainably decouple?

Will there be another systemic event concerning sovereigns or banks?
In this time of unusual uncertainty, businesses on either side of the border are responding in
different ways. In the United States, investment has been relatively strong and productivity
growth has been robust. However, hiring has been unusually weak, particularly by small
businesses. In Canada, the opposites have been the case: investment has been unusually
weak; productivity, poor; and hiring, strong, particularly amongst small and medium-sized
enterprises (SMEs).
I would like to speak today about the possible reasons for these divergences, how long they
are likely to persist, and their implications for growth and inflation in Canada.
The global economic outlook
The global recovery is entering a new phase. The easy bit is now over. In advanced
economies, the temporary boost from the turn in the inventory cycle is largely complete. In
many countries, fiscal stimulus is turning to fiscal drag. The panicked postponement of
consumption and investment has been unwound. The question now is whether growth in
advanced economies will be self-sustaining in the face of broad forces of bank, household,
and sovereign deleveraging.
The evidence is mixed, depending on proximity to the crisis. For example, in Germany,
where household and government finances are sound and the economy is externally
oriented, growth has picked up smartly. In peripheral Europe, where households and
governments are extremely leveraged and economies have been domestically focused,
growth is slowing rapidly.
Similar forces threaten renewed weakness in the United States. For Canada, this prospect is
of concern.
Financial markets are currently constructive but remain vulnerable to event risk. Renewed
pessimism over the U.S. outlook has sharply reduced global bond yields. In effect, there has
been a Goldilocks deterioration in the macro-financial environment as major government
bond yields have fallen sharply but corporate spreads have not increased (Chart 2). For
large corporations who want it, finance is readily available at historically low all-in costs.
In emerging economies, growth has persistently surprised on the upside. Healthy financial
sectors and very stimulative monetary and fiscal policies have overcome the drag from
weaker export markets. However, with the limits to non-inflationary growth approaching and
the challenges of shadowing U.S. monetary policy increasing, this above trend growth is
likely to come to an end.
In sum, there are several reasons to expect a modest and uneven global recovery. Not all
countries can simultaneously export their way to growth. The ongoing process of balance
sheet repair in major industrialised countries will restrain household consumption and
business investment. The ability of some major emerging markets to maintain persistently
higher domestic demand remains unproven. Finally, necessary real exchange rate
adjustment threatens to come through inflationary pressures in emerging economies and
deflationary pressures in major advanced economies rather than (far easier) changes in
nominal exchange rates.
These forces make the economic outlook and policy environment unusually challenging for
countries caught in the middle, like Canada.
The U.S. economic outlook
When faced with a potential collapse in private demand in the wake of the financial panic,
U.S. authorities instituted massive and timely monetary and fiscal stimulus. This bought time
for the necessary adjustments in the economy to begin. With U.S. fiscal policy transitioning
from expansion to contraction, that time is now coming to an end. The success of the
necessary handoff of growth from the public to the private sector is still in question (Chart 3).
The U.S. housing sector remains very weak, despite substantial falls in prices and housing
starts. Valuations are more in line with historical averages, and inventories of unsold new
homes have reached their lowest level since 1968. However, effective supply is much larger,
given the overhang of distressed properties and the pent-up supply of "shadow inventories"
in the resale market. Housing demand continues to be held back by subdued consumer
confidence, the weak labour market, and the inability of some households to access
financing, at historically low mortgage rates. While there appears to be limited prospect for
substantial further deterioration in U.S. housing, a sharp rebound in the near term looks
unlikely.
U.S. businesses have responded to the challenging environment by increasing productivity.
While commercial real estate investment has been unusually depressed, investment in
equipment and software has been robust and consistent with prior recoveries (Chart 4).
The same cannot be said of the U.S. labour market, which has borne the brunt of
adjustment. The unemployment rate remains very high at 9.6 per cent, the incidence of
longterm unemployment reached a record level above 40 per cent (Chart 5), and
underemployment in the form of involuntary part-time work is rampant.
The prolonged weakness in the U.S. labour market reflects factors that go beyond weak
output growth. The jump in the unemployment rate has been higher, by about 5 million
workers, than the decline in GDP would have traditionally suggested. The restructuring of
major industries such as autos, finance and of course, construction has deepened the job
losses. In addition, credit constraints facing U.S. SMEs have contributed to the employment
dynamics.1
The natural rate of unemployment may be increasing sharply. The scale of industry
restructuring means that some unemployed workers do not have the skills suitable for the
expanding sectors. Other jobseekers are tied to their local area, due to an inability to sell
their homes in distressed markets, hampering the mobility that has been a hallmark of the
American labour market. The current cycle is also self-reinforcing. As long-term
unemployment becomes more entrenched, workers' skills deteriorate and their reintegration
into the labour force becomes more difficult.
Reflecting weakness in the labour market and an ongoing need to repair stretched personal
balance sheets, U.S. real personal expenditures are not yet back to pre-crisis levels. Two of
the most visible indicators of this weakness matter tremendously to Canada: housing starts
and motor vehicle sales (Charts 6a and 6b).
The good news is that recent data revisions indicate that the personal savings rate is now at
6 per cent, which is consistent with ultimately rebuilding U.S. household wealth to historic
averages and stabilizing the U.S. net foreign liability position. If savings hold at this level (that
is, absent a further shock to confidence), then consumption should grow next year at a
moderate pace.
The Canadian economic outlook
Despite this challenging external environment, Canada's recovery has been stronger than
that of its G-7 peers. As a result of the combination of the scale and speed of the policy
response and our well-functioning financial system, Canada's economy is now back at its
pre-crisis peak in output. However welcome, our recovery is relatively modest in comparison
to its predecessors and has relied heavily on housing and personal consumption.
The limitations of this reliance are becoming evident. In recent months, the speed of the
recovery has diminished. A modest pace of growth can be expected in coming months as our
economy faces considerable headwinds from both the external sector and the limits of
household balance sheets.
Allow me to expand.
Housing activity in Canada is declining markedly from high levels, as the Bank had expected.
The slowing since the spring in resale, renovation, and new home construction activity has
been driven by a number of factors, including the passing of pent-up and pulled-forward
demand; the expiration of the federal Home Renovation Tax Credit in January; the tightening
of standards for government-backed insured mortgages that came into effect in April; the
introduction of the HST in Ontario and British Columbia in July; declining affordability; and
subdued income growth. I will come back to that last factor in a moment, but overall it
appears unlikely that private consumption will be bolstered by substantial house price gains
going forward.2
The fiscal stimulus is also coming to an end. After making a major contribution to growth
since the onset of the recession (Chart 7), the Bank estimates that the contribution of
government spending to real GDP growth will turn negative in 2011.
Until recently, business investment has disappointed relative to past experience as well as to
the imperatives of lagging productivity, increasing international competition, and the
development of major opportunities in emerging markets. Survey evidence and recent data
suggest that is now changing. The Bank expects that business investment will increase to
levels consistent with previous recoveries, reflecting competitive imperatives, firms' strong
financial position, and easy credit conditions (Chart 8).
The auto sector provides an example. The recession crystallised a major restructuring, with
North American capacity reduced by 3 million motor vehicles.3 More than 576,000 jobs were
lost since December, 2007. Today, U.S. demand for motor vehicles is about 11 million per
year versus the average from 2000 to 2006 of 17 million, and while there will be some growth
from here, the U.S. market is likely to be persistently smaller as households reduce debt.
As a consequence, business models are now being substantially adjusted. Canada is
competing to host some of the handful of global OEM (original equipment manufacturer)
platforms, training, R&D, and capital investment are being ramped up, and some Canadian
tier 1 suppliers are aggressively expanding into emerging markets.
Similar bold moves will be required across our economy to create sustainable, wellpaying
jobs.
Labour market dynamics in Canada
The most striking thing about the Canadian recovery has been the performance of the labour
market (Chart 9). All 400,000 jobs lost in the recession have now been recovered. While the
unemployment rate remains high at 8.1 per cent, this reflects in the aggregate the movement
of more people into the labour force. With this, the incidence of longer term unemployment in
Canada is about half that in the United States.
However welcome, these headline figures mask some important details. Much of the
employment growth is in the public sector, with only half of the new jobs in the private sector.
Many jobs are involuntary part-time. In fact, although employment has regained its
prerecession level, hours worked have not. Overall labour input (the combination of employment
and hours worked) has made up only two-thirds of its decline during the recession.
Since the crash, on the margin, the composition of labour demand has shifted from jobs in
the goods sector to jobs in the services sector. The change accounts for the majority of the
gap between the current level and the pre-recession level of average hours worked. In the
current cycle, the goods sector, such as autos, has experienced far more adjustment than
services, such as retail. This appears to be largely a result of the export-oriented nature of
the shock and the strength of the Canadian dollar. These dynamics would be familiar here in
Windsor-Essex, where the unemployment rate is about 3 percentage points above the
national average.
The Bank expects that average hours worked will return to its trend, but only very gradually.
Those in involuntary part-time positions should eventually find full-time ones. This view is
anchored by an expected slow recovery in goods sector employment, which in turn reflects
our expectations for the pace of recoveries in U.S. demand and Canadian business
investment. If the U.S. falters or the acceleration in Canadian business investment flags, then
the pace of improvement in the labour market will be slower.
Household balance sheets and the outlook for consumption
With Canadians working, but not as much as they would like, they have been borrowing.
Real household credit expanded rapidly throughout the recession, in contrast to previous
downturns, and has continued to grow through the recovery. Canadian households have now
collectively run a net financial deficit for 37 consecutive quarters. That is, their investment in
housing has outstripped their total savings for over nine straight years. In effect, households
are demanding funds from the rest of the economy, rather than providing them, as had been
the case through the 1960s, 1970s, 1980s and 1990s (Chart 10).
This cannot continue. The ratio of Canadian household debt to disposable income reached
146 per cent in the first quarter of this year, an all-time high and very close to the current
level in the United States (Chart 11). In a series of analyses over the past year the Bank has
found that Canadian households are increasingly vulnerable to an adverse shock and that
5
this vulnerability is rising more quickly than had been previously anticipated.4,
It is true that the strength of housing and other assets has meant that the net worth of
Canadians remains about six times their average disposable income compared with slightly
below five times in the United States. However, while asset prices can rise or fall, debt
endures. Despite the buoyancy of the housing market, the debt-to-asset ratio has risen to its
highest level in more than 20 years.
In short, Canadian household balance sheets are becoming increasingly stretched. It is
possible that Canadians are beginning to address some of these vulnerabilities. This would
be consistent with recent data that indicate a slowdown in household consumption
expenditures and housing activity, amid a labour market recovery that has been longer on
jobs than on hours or incomes.
The Bank expects balance-sheet considerations will remain important ahead, likely limiting
consumption growth to a rate more consistent with income growth over the medium-term
horizon.
Reflecting recent developments, inflation in Canada has been slightly lower than the Bank's
expectations, with core CPI of 1.6 per cent and total CPI of 1.7 per cent in August. However,
its dynamics are essentially unchanged. Inflation expectations are well anchored at the
2 per cent target. Developments in the labour market described earlier, combined with
expenditure restraint in the public sector and a pickup in labour productivity, should
contribute to restrained growth of unit labour costs. This downward pressure on inflation is
expected to be offset by the gradual absorption of excess supply as the economy grows. As
has been the case with previous changes in indirect taxes, for the purposes of monetary
policy, the Bank will look through the first-round effect of recent changes in provincial sales
taxes on prices.
Policy implications
A durable global recovery requires a major rebalancing of global supply and demand. This
will be a slow process, measured over a decade. During this period of adjustment, we should
expect subdued growth in major advanced economies. Consider that in the 10 years
following a typical financial crisis, the median rate of output growth in the crisis economy
decreases by 1 per cent and the unemployment rate increases by 5 percentage points.6 The
United States is tracking this path.
In such an environment, very low policy rates could be in place for longer, and
unconventional monetary policies could even be expanded in some major countries. But
clearly, monetary policy alone will not be enough. Advanced economies need to chart a
course for fiscal sustainability, complete an ambitious restructuring of their financial systems,
and implement domestic structural reforms. Emerging economies need to expand domestic
demand and fulfill commitments to enhanced currency flexibility. Ultimately, all countries
need to create a more flexible, open international monetary system to complete the
transformation to a multi-polar world.
The Bank of Canada is working with other major central banks on this vital international
agenda but, ultimately, our most important contribution to the economic welfare of Canadians
is to continue to deliver price stability as defined by our 2 percent inflation target.
In response to the sharp, synchronous global recession, the Bank lowered the target rate
rapidly over the course of 2008 and early 2009 to its lowest possible level. We almost
doubled our balance sheet to provide the financial sector with exceptional liquidity. With our
conditional commitment, the Bank provided exceptional guidance on the likely path of our
target rate. These policies provided considerable additional stimulus during a period of very
weak economic conditions and major downside risks to Canadian economy.
With the initial rapid narrowing of the output gap, the return of employment to its precrisis
peak, the highly effective transmission of monetary policy in Canada, and the sustained
momentum in household borrowing, the need for such emergency policies passed.
Since the spring, the Bank has unwound the last of our exceptional liquidity measures,
removed the conditional commitment, and raised the overnight rate to 1 per cent. Following
these actions, financial conditions in Canada have tightened modestly but remain
exceptionally stimulative. This is consistent with achieving the 2 per cent inflation target in an
environment of still significant excess supply in Canada and the demand headwinds
described earlier. While Canada's circumstances and the discipline of the inflation target
dictate a different policy stance than in the United States, there are limits to this divergence.
At this time of transition in the global recovery, with risks of a renewed U.S. slowdown, with
constraints beginning to bind growth in emerging economies, and with domestic
considerations that will slow consumption and housing activity in Canada, any further
reduction in monetary policy stimulus would need to be carefully considered. The unusual
uncertainty surrounding the outlook warrants caution.
Historically low policy rates, even if appropriate to achieve the inflation target, create their
own risks. Aside from monetary policy, Canadian authorities will need to remain as vigilant as
they have been in the past to the possibility of financial imbalances developing in an
environment of still low interest rates and relative price stability.
Conclusion
Today's venue honours Giovanni Caboto, who, more than 500 years ago, combined the
navigation skills of his home in Genoa with the commercial initiative of his Bristol sponsors to
make landfall in Canada. His voyage marked the start of the opening of North America to
global commerce. Similarly today, Canadian business must open new markets.
The world's economic centre of gravity is again shifting. With the integration of one-third of
humanity into the global economy, the world is rapidly becoming multi-polar.
Emergingmarket economies are now the main drivers of commodity prices, they represent almost
onehalf of the growth in all imports over the past decade, and they currently account for about
two-thirds of global growth. In contrast, the United States is undergoing a protracted
adjustment, which will subdue demand for Canadian goods for the foreseeable future.
Canadians must respond. As a country we are under exposed to the economies that will
drive global growth. The imperatives for business appear clear: new suppliers need to be
sourced; new markets opened; and a new approach to managing for a more volatile
environment developed. Workers need to build skills and be prepared to shift jobs and even
careers, if necessary.
Business in Windsor-Essex has started. Our auto sector is undergoing a major restructuring
and is emerging more competitive. There are recent signs that other sectors are beginning to
follow. If business can sustain and then broaden this early momentum, all Canadian workers
will be fully and productively employed.
Appendix
BIS Review 127/2010
BIS Review 127/2010
BIS Review 127/2010
BIS Review 127/2010
BIS Review 127/2010
BIS Review 127/2010