Carolyn Wilkins: Canadian economic update - strength in diversity
Remarks by Ms Carolyn Wilkins, Senior Deputy Governor of the Bank of Canada, at the
Associates of the Asper School of Business, Winnipeg, Manitoba, 12 June 2017.
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Introduction
I am very pleased to join you here in Winnipeg. Thank you to the Associates of the Asper School
of Business for the invitation.
I was able to get out for a run this morning at The Forks. It is a beautiful area, and I was struck by
the impressive architecture of the Canadian Museum for Human Rights.
I am looking forward to visiting it this week. The museum reminds us that all people are worthy of
respect and dignity, regardless of their differences. The 150th anniversary of Confederation of
Canada is the perfect opportunity to reflect on the strength that comes from diversity. Just a
couple of weeks ago, the Bank of Canada issued a commemorative bank note that celebrates
the diversity of our nation builders and of our landscape.
Diversity comes in many forms, and today I will speak about economic diversity and the strength
that comes from having multiple sources of growth. As you will remember, the Canadian
economy was hit hard by the collapse in oil prices in 2014. The adjustment to lower oil prices is
now largely behind us, and we are looking for signs that the sources of growth are broadening
across sectors and regions. As I will explain, the signs are encouraging.
My colleagues and I spend a lot of time poring over data to see how the economy is evolving.
Data rarely tell the whole story, though, which is why we also spend a lot of time talking to
people, firms, financial market participants, industry associations, labour groups and others. We
do this through formal surveys on important economic issues and through outreach discussions.
And, for years now, the Bank has held one of its Board of Directors' meetings outside Ottawa
every year.
In fact, there is a Board meeting in Winnipeg this week, and we will have an opportunity to
exchange views with local business people and other community members. We are looking
forward to these discussions because this province is a vibrant microcosm of the Canadian
economy.
While Manitoba has a number of unique dimensions-ranging from world-class ballet to
worldclass winters-it shares almost the same structure as the overall Canadian economy when it
comes to sources of gross domestic product (GDP) (Chart 1).
Manitoba's diverse economy has been a source of strength over the past decade. Its economy
has expanded by slightly more than 2 per cent a year on average since 2006. That is about half a
percentage point higher than the Canadian economy overall for the same period.
As I talk about economic diversity today, I will first explain why it matters to a central bank whose
main goal is to achieve low, stable and predictable inflation. I will then walk you through what key
sets of information are telling us. Finally, I will outline some of the issues that we are considering
as we prepare for our next economic update. This will be published in our Monetary Policy
Report on 12 July, along with our interest rate decision.
Why diversity matters
Diversity comes in many forms. Let me mention two that relate to the Canadian economy. The
first is diversity with respect to our nation's industrial structure, in other words, the range of
goods and services produced in Canada. This is important because sectoral diversity makes the
economy more resilient-although not immune-to shocks. It is the economic equivalent to not
putting all of our eggs in one basket. Anyone who has attended business school or managed an
investment portfolio will be familiar with the benefits of diversification.
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Let us remember, Canada has benefited over history from its wealth in natural resources. But
when oil prices fell from their highs in mid-2014, the regions of Canada that rely on the oil and
gas sector were hit hard. As these regions underwent a difficult adjustment process, sectors in
other parts of the country were able to help absorb the slack that was created. The service
sector was a primary force. That demonstrates the benefit of diversity in the Canadian economy.
Monetary policy stimulus and a lower dollar together provided critical support to aggregate
demand and facilitated the adjustment of labour and capital. You will remember that the Bank of
Canada reduced the policy rate by 50 basis points in 2015, to near-historical lows.
The second form of diversity-which I will focus on today-relates to the sources of economic
growth. Generally speaking, while growth might bounce around from quarter to quarter, it is more
likely to be sustainable over the medium term if its sources are broad-based. For example,
growth in exports helps generate the income required to sustain growth in household spending
without the need to borrow from abroad. Similarly, demand growth is more likely to be
sustainable if matched by growth in capacity-enhancing business investment. There are also
important sectoral and geographic aspects to sustainability.
While broad-based growth is desirable, it is not under the direct control of monetary policy, and it
is not our objective. We target a 2 per cent inflation rate. That means that it is the outlook for
overall inflationary pressure and related risks that matters most when we consider the
appropriate stance for monetary policy. So even if only a few sectors were expanding enough to
absorb the excess capacity in the aggregate economy, we would need to take the appropriate
monetary policy action to meet our inflation target.
So let us look at how the economy has been performing recently.
Signs that growth is broadening
When we assess the extent to which the sources of growth are broadening, we look at the
economy from a number of perspectives. These include the progress made in adjusting to lower
oil prices, the range of industries that are growing and the evolution of the labour market. As I
discuss each in turn, I will point to some signs that growth is broadening across regions and
sectors, although not to the same extent.
Adjustment to lower oil prices
Let us start with the adjustment to lower oil prices. In 2015 and 2016, the starkest effects of the
drop in oil prices on GDP were in business investment. Firms in the oil and gas sector cut capital
spending in half, shutting down oil rigs and cancelling investment plans. Investment in the rest of
the economy was also subdued, in part as a result of the weakness in non-commodity exports,
especially last year. The economy kept growing, thanks to household spending, and activity was
concentrated in regions where the energy sector was not as important.
Today, as we move past the adjustment to lower oil prices, we are seeing the economy pick up.
A couple of weeks ago we got the national accounts data from Statistics Canada for the first
quarter of this year. It was pretty impressive, with growth at 3.7 per cent. And the figures show
business investment growing again. This is in large part because capital expenditures in the oil
and gas sector have bounced back. That is good news. That said, investment growth in this
sector is likely to moderate if oil prices stay around where they are today. More generally, ongoing
uncertainty about the policies of the US administration is weighing on investment plans. And,
given how business investment has declined in the past two years, we flagged it as one of the
downside risks to the outlook in our April Monetary Policy Report.
Growth in the first quarter was also fuelled by the usual suspects-consumer spending and
residential investment. However, growth in the housing sector is expected to slow from
exceptionally high rates, and we are already seeing this in the most recent data on housing starts
and resales. It is too early to tell how the recent housing measures introduced in Ontario will
ultimately affect activity and prices in and around Toronto. In Vancouver, when similar measures
were introduced last year, we saw the market cool for a period of time. But it is picking up again.
So, given we expect household spending to slow somewhat, it could surprise us and provide an
unexpected boost to growth in the near term, which is another risk we mentioned in April.
Higherthan-expected spending, if funded by credit, could add to the vulnerabilities in the household
sector. We have been monitoring these for some time and highlighted them in last
week's Financial System Review. In this regard, the recent policy measures taken by federal and
provincial governments are welcome.
If there was one disappointment in the first-quarter figures, it was exports. We actually saw a
decline of exports of services, which had been performing very well. At the same time, goods
exports were flat. We have been working hard to understand the forces behind the data.
Stepping back from the quarterly data, there are other signs of adjustment. We see indications
that demand in energy-intensive provinces is strengthening, after having fallen in 2015 and the
first half of 2016. You just need to look at motor vehicle sales and housing resales (Chart 2).
One challenge we have when assessing the geographic diversity of growth is that it takes longer
for provincial data to be published-this year's data on growth by province will not be available
until well into 2018. That is why Bank of Canada staff recently developed models to get a timelier
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read on provincial GDP. These models point to a broadening in provincial activity this year, in
contrast to the lopsided growth we have seen over the past couple of years (Chart 3).
We also see a regional broadening of demand in the results of our most recent Business
Outlook Survey. This survey asks 100 businesses every quarter about things like sales,
employment and investment intentions. Executives across the country responded more
optimistically about their future sales and their investment plans than they were just a few
quarters ago.
Range of growing industries
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We also see a broadening when it comes to growth across industries (Chart 4). We can see
the adverse effect the oil price shock had on goods production in 2015 and the first half of 2016.
The fact that growth was positive overall was due to a resilient service sector. As the oil and gas
and related sectors stabilized, the goods sector as a whole started contributing again.
What is encouraging is that this growth is not being driven by just a few key industries. The data
show that more than 70 per cent of industries have been expanding-a rate we have not seen
since the oil price shock. That is the kind of diversity that helps support strong and sustained
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overall growth.
When we think about the main drivers of economic growth, many of us picture industries like
mining, motor vehicles or aerospace. While these sectors still matter a great deal to the
economy, many service industries are increasing in importance. Computer systems design and
related services have been growing nearly 10 per cent in the past year. This sector is now as big
in Canada as motor vehicles and aerospace combined. It is not all about computers-more
areas of the service sector, such as financial services and air transportation, are engines of
growth. This is helping to support the household spending we have seen.
Labour market developments
Let me turn now to labour markets. Developments here are largely consistent with the evolution
of economic activity I just discussed. It is not surprising that job growth in the past couple of
years had been concentrated in services, offsetting significant losses in goods employment.
Jobs in goods-producing industries are now on the rise, and the share of sectors adding workers
is growing.
Some sectors stand out. The technology sector has been creating a lot of jobs, many of which
are very well paid. Other sectors that have seen strong job growth include finance and insurance,
health care and education.
As sources of growth become more diverse, gains in employment are spreading across the
country (Chart 5). Now, we know that the adjustment in the labour market is still under way in
some regions, and this is difficult for many people and their families. Alberta and Newfoundland
and Labrador, in particular, have not recovered all the jobs lost in the aftermath of the oil price
shock.
Taking care of business
Being able to judge the sustainability and evolution of growth is critical for a forward-looking
central bank that targets inflation over the medium term. To meet this objective, we use our
policy interest rate to stimulate or slow economic activity, depending on how we judge the
evolution of inflationary pressures. Once inflation reaches our target, maintaining it there requires
growth to be sustained at the economy's speed limit-what we refer to as "potential output
growth." Low, stable and predictable inflation, in turn, allows people to make financial decisions
with more confidence.
Monetary policy actions influence financial conditions and economic decisions right away but can
take as long as two years to have their full effect on inflation. To ensure that inflation gets back to
target on a sustainable basis, we must consider not only current economic conditions but also
how they will evolve. If you saw a stop light ahead, you would begin letting up on the gas to slow
down smoothly. You do not want to have to slam on the brakes at the last second. Monetary
policy must also anticipate the road ahead.
Right now, slack in the economy is still translating into inflation that is below our target. Headline
inflation stood at 1.6 per cent in April, in part because of the transitory effects of competition
among food retailers. We look at several measures of core inflation to see past the transient
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volatility in headline inflation. These measures have drifted down in recent quarters and range
from 1.3 to 1.6 per cent. This is consistent with the lagged effects of excess supply in past
quarters.
Other indicators also point to ongoing spare capacity. We have seen moderate growth in wages,
and the number of hours that people work has only recently picked up, although employment
growth has been strong. Our base-case projection in the April Monetary Policy Report was for
the output gap to close sometime in the first half of 2018 and inflation to return sustainably to
target around the same time.
We are in the process of doing our next projection, which will be released in July. We will digest
all the new data since the April Report and update our assessment of inflationary pressures. We
will also look at how the main risks we highlighted in that report have evolved. I have already
mentioned the risk of slower investment growth and the risk of stronger growth in household
spending. We also underscored the risk that even stronger growth in the United States could
lead to a big jump in business confidence, igniting "animal spirits" as John Maynard Keynes
would have put it. And, given that we do not know how much capacity might be rebuilt as the
economy expands, we pointed to the possibility that potential growth may be stronger than
assumed in our base-case projection.
We are all acutely aware of the uncertainty around the policies of the US administration-
whether it is about trade, tax or the regulatory environment. We already factored in some of the
effects of that uncertainty in our April outlook. Until we get more information, it will be difficult to
gauge the impact of any proposed policy changes more precisely. This will likely remain an
important uncertainty in our projection, but life goes on and decisions must be made in the
meantime.
Our judgment on the appropriate stance of monetary policy will continue to be based on the
outlook for inflation and on the full range of risks-both upside and downside-to that outlook. An
important aspect of our inflation assessment is that the economic drag from lower oil prices is
now largely behind us. And the 50 basis point reduction in our policy rate in 2015 has facilitated
this adjustment. As growth continues and, ideally, broadens further, Governing Council will be
assessing whether all of the considerable monetary policy stimulus presently in place is still
required.
Conclusion
Time to wrap up.
There are still risks to the Canadian economic outlook. That said, when you look at the economy
from different perspectives, there is reason to be encouraged. Growth has been robust in recent
quarters. As we celebrate Canada's 150th birthday and the strength that comes from the
diversity of its people, we are seeing the benefits of its economic diversity as well.
The strengthening economic activity in regions and sectors that rely on energy is working to
diversify the sources of growth across the country. And, while there is still room for improvement
in the labour market, stronger growth is translating into job gains across a wider range of regions
and sectors.
At present, there is significant monetary policy stimulus in the system. As we work toward our
interest rate decision on 12 July, we will be focusing on the data and talking to many people like
you to get a better sense of what is happening on the ground.
One thing that remains clear is the Bank's commitment to achieving its inflation target so that
Canadians can make their financial decisions with more confidence.
The goods sector includes oil and gas, mining and manufacturing, while the service sector includes trade,
transportation, digital and professional services, health care, education and public administration.
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To examine the breadth of activity over a given period of time, we constructed a diffusion index that includes the
22 subcomponents of GDP at basic prices and measures the proportion that are growing. This index has been
increasing since the third quarter of 2016.
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The measures are CPI-median, which is based on the price change located at the 50th percentile (in terms of
the CPI basket weights) of the distribution of price changes; CPI-trim, which excludes CPI components whose
rates of change in a given month are located in the tails of the distribution of price changes; and CPI-common,
which tracks common price changes across categories in the CPI basket.