Mark Carney: The coming thaw
Remarks by Mr Mark Carney, Governor of the Bank of Canada, to the Winnipeg Chamber of
Commerce, Winnipeg, Manitoba, 4 February 2010.
* * *
It is a pleasure to be here in Winnipeg. Today, I intend to elaborate on elements of the Bank
of Canada's economic outlook.
After putting the recession in context and offering the Bank's perspective on the shape of the
recovery, my remarks will focus on Canada's corporate sector. A focus on business is
appropriate in Manitoba. This province is not only the geographic centre of our country, but
also mirrors Canada's economic diversity. Manitoba's distinctive blend of primary,
manufacturing, and service businesses represents a true cross-section of the Canadian
economy. A focus on business is also appropriate at this stage of the economic cycle. A key
determinant of the pace and sustainability of Canada's recovery will be how investment and
hiring intentions of businesses in all sectors evolve as policy stimulus begins to fade.
My message is relatively straightforward: the thaw is coming. That may sound a little
premature to someone standing at the corner of Portage and Main in early February, but it
broadly captures the state of our economy. While its pace will likely be somewhat muted
(given the depth of the recession) and while there may be setbacks, the recovery has begun.
After a brutal economic winter, spring is within sight.
There is, however, a catch. The economic climate that Canadian business will face will be
considerably different. Canada is entering this period of adjustment with many strengths, but
the efforts required of us will be historic.
The global recession
In the fall of 2008, the intensifying financial crisis triggered a deep, synchronous global
recession. The economic shock in the United States was spread - and in many cases
amplified - through trade, finance, and confidence channels. We are just emerging from the
worst economic downturn since World War II.
The speed and virulence of the slowdown took business by surprise. Over the turn of last
year, there was the equivalent of a corporate heart attack: inventories surged, production
was slashed, capital spending budgets eliminated, and employment cut. The cascade of
collapsing demand through global supply chains shook widely held perceptions. Given the
shock of the downturn, many firms understandably have been waiting for confirmation of the
recovery before acting.
The Canadian recession in context
Canada experienced a short, sharp recession. In its depths last year, with the exception of
government spending, all major components of aggregate demand declined. At its worst,
industrial production fell 15 per cent. Canadian exporters suffered particularly, owing to the
sharp fall in the components of U.S. economic activity that matter most for Canada. For
example, U.S. demand for motor vehicles fell by more than half and housing starts by
twothirds.1 In response to this new profile of U.S. demand, major Canadian industries
(particularly the automotive and forestry sectors) began deep restructurings, which continue
to this day.
The recession has had a considerable impact on employment. At its depth, 400,000
Canadians lost their jobs and the unemployment rate spiked by almost 3 percentage points
to its highest level in more than a decade. Although the deterioration of the labour market
appears to have stopped, too many Canadians who want to work are still out of a job, and
many of those still employed are working fewer hours than they would like.
As painful as our recession was, Canada has suffered less than most other advanced
economies. Domestic demand, fixed capital investment, and employment in Canada all held
up substantially better than in the United States. Real GDP fell cumulatively by 3.3 per cent
in Canada. That compares with declines of just less than 4 per cent for the United States,
about 5 per cent for the Euro area, 6 per cent for the United Kingdom, and more than 8 per
cent for Japan.
Canada's better performance can be explained by two factors. First, with a highly credible
monetary policy and the strongest fiscal position in the G-7, Canadian policy-makers were
able to respond swiftly and effectively with extraordinarily accommodative measures. The
Bank of Canada began cutting interest rates in December 2007 and proceeded with a series
of aggressive reductions until our key policy rate reached one-quarter of one per cent in April
of last year, the lowest it can effectively go. Further, the Bank then provided extraordinary
guidance on the likely path of interest rates necessary to achieve the inflation target in order
to maximize the monetary stimulus from its policy rate. Fiscal stimulus has already been
substantial and will continue to have an important impact on growth this year.
Second, Canada entered the recession with notable advantages, including a well-functioning
financial system, strong corporate balance sheets, and relatively healthy household finances.
In addition, our economy has a demonstrated ability to adjust quickly to changing
circumstances.
We will have to draw on these advantages as the world emerges from recession. While the
downturn was synchronous, economic performance across markets and sectors is likely to
be increasingly diverse. For some Canadian businesses, the recovery may prove as
challenging as the downturn.
Global economic recovery
The global recovery, which began in the second half of last year, can be characterized as
multi-speed and policy-led.2 In the industrialized countries, growth is relatively sluggish and
heavily dependent on the exceptional monetary and fiscal policy stimulus, as well as the
extraordinary measures taken to support financial systems. In emerging markets, where
internal demand is already more robust, policy support is beginning to be withdrawn.
Ultimately, the sustainability of the recovery depends on the private sector. As yet, there are
few indications of autonomous private demand in most advanced economies. In these
countries, high unemployment rates, still-challenged financial sectors, and weak household
balance sheets will slow the return to pre-crisis growth rates. In this regard, the strength of
Canadian domestic demand (currently the strongest in the G-7) is noteworthy.
In many economies, it will take time for real output to return to pre-crisis levels. For example,
although the Bank expects that the Canadian economy will attain its pre-crisis peak by the
third quarter of this year, it will be yet another year and a half before the European and
Japanese economies do the same. In contrast, many major emerging economies are already
operating well above pre-crisis levels.
This is just one illustration of how the nature of the world economy has changed. Indeed,
was
despite its brevity, this the Great Recession. Recent events will likely have far-reaching
repercussions. Over the medium term, the pattern and pace of global growth could be
significantly altered. The rate of potential growth in the global economy has likely fallen and
will take time to rebuild. The rotation of global demand and the restructuring of corporate and
household balance sheets are generating important headwinds to economic activity in
advanced economies. Conversely, emerging markets are becoming more dominant in the
global economy.3
Global growth may not only be lower in the future, but could also be more volatile as a result
of some fundamental vulnerabilities. First, fiscal pressures will be immense. Once the
recovery is assured, most economies will need to make concerted efforts to restore fiscal
sustainability. But with the debt-to-GDP ratio in industrialized countries expected to rise from
80 per cent, pre-crisis, to 120 per cent by 2014, this challenge should not be underestimated.
Even abstracting from the difficult political decisions that will be required in many countries,
policy-makers will have to balance the fiscal drag from reducing deficits against the dangers
of crowding the private sector if they are not.
Second and more immediately, capital inflows to emerging-market economies are creating
new pressures. By both resisting exchange rate appreciation and forestalling monetary
tightening, these countries are increasing the risk that their economies will overheat. As a
stopgap, some of these economies are resorting to regulatory measures4 of unproven
effectiveness. The net result could be higher growth in the short term followed by a sharp
contraction later on.
Third, policy-makers must ensure that business can operate, as much as possible, in an
open and stable trade and regulatory environment. We must live up to the G-20 commitment
to resist trade and financial protectionism. It is also essential to maximize the degree of
regulatory certainty and coordination across countries as we move forward on vital financial
sector reforms. Further progress on this will be one of Canada's priorities for this weekend's
G-7 meeting in Iqaluit.
Securing strong, sustainable, and balanced global growth will require changes in behaviour
and policy adjustments on several fronts.5 These include: a sustained fiscal consolidation in
the United States and several other advanced countries; an upward adjustment of U.S.
household savings; increased, policy-induced domestic demand in China and other major
emerging-market economies; and a real exchange rate appreciation in countries with large
current account surpluses.
Should these conditions fail to materialize over the medium term, two, equally troubling,
paths for the global economy are possible. First, a return to the large, and unsustainable,
current account imbalances of the past cannot be discounted. This would only serve to build
financial imbalances anew. Alternatively, the combination of fiscal contraction over a number
of years and the real prospect of ongoing sluggishness in private consumption in some major
economies creates the possibility of deficient demand, with sharp disinflationary pressures at
a global level. This scenario can be avoided by the development of new sources of domestic
demand in major emerging markets and some surplus industrial countries.
Business outlook
Against this backdrop of relatively subdued global and U.S. growth, domestic factors in
Canada will prove decisive for the recovery in the near term. Current strength in housing
3
About three-quarters of global economic growth is represented by emerging-market economies this year and
next, compared with two-thirds in the pre-crisis decade (1998-2007).
demand and consumer spending will provide important impetus this year.6 Owing to the
improved financial and economic conditions, 2010 should mark the hand-off from growth that
is heavily influenced by public policy to growth that is largely determined by the private
sector. By next year, the private sector should be the sole contributor to domestic demand
growth in Canada.
Canada's corporate sector begins with a number of advantages. Domestic demand is
expected to be relatively strong, providing a base of support for some sectors. Corporate
balance sheets are in outstanding shape, and margins have held up very well for this stage
in the economic cycle.
In addition, Canada's overall financial conditions are now contributing to, rather than
retarding, the recovery. While net financing needs would be expected to be limited, given the
stage in the economic cycle, business credit has started to grow again. In part due to
monetary stimulus, overall borrowing costs for Canadian businesses remain very low.7
Taken together, results from the Bank's latest Senior Loan Officer Survey and the Business
Outlook Survey suggest that, following a period of substantial tightening, credit conditions for
businesses eased slightly in the fourth quarter of 2009, for the first time since the financial
crisis began. The improvement in credit conditions mainly affected large firms, as some small
and medium-sized entities continued to experience tightened conditions.
It is in this environment that the first signs of a thaw in corporate attitudes have begun to
emerge. In our latest Business Outlook Survey, more firms said they are now planning to
increase investment spending and employment than did either last summer or fall.8 With the
improvement in financial conditions, economic activity, commodity prices, and growing
confidence, business fixed investment should pick up in 2010. This recovery will be relatively
modest; it is not until 2011 that we anticipate an acceleration of investment spending, as the
excess supply in the economy is taken up.
However, given the external environment, the question is whether this pickup will be
sufficient. The significant drop in investment that occurred during the recession included
spending on new technology, which could have helped firms address coming economic
challenges. The relatively slow recovery expected in our most important trading partner,
along with ongoing sectoral adjustments, means that firms have to find new markets. In
doing so, they will face increased competition. For example, due to exchange rate moves
and stellar productivity performance, the competitiveness of the U.S. corporate sector has
improved significantly. The need for capital investment by Canadian businesses to meet
these challenges is clear.
In short, Canadian companies are emerging from the recession to an altered world - one that
may require deeper restructuring and bolder strategic initiatives than currently contemplated.
New suppliers need to be sourced; new markets opened; a new approach to managing for a
more volatile environment developed. To recognize this reality is also to recognize the
opportunities available to corporate Canada.
6
For more detailed discussions of these components of domestic demand, see Mark Carney, "Current Issues in
Household Finances," remarks delivered to the National Forum (Canadian Club of Toronto and Empire Club of
Canada) in Toronto, 2009, and Timothy Lane, "Canada's Housing Sector in Recession and Recovery: Beyond
Bricks and Mortar," remarks prepared for delivery to the Edmonton CFA Society, 2010. Available at
http://www.bankofcanada.ca/en/speeches/.
7
Borrowing spreads paid by households and businesses spiked in 2008, but fairly quickly dropped back and
now are within the normal range. The Bank expects these spreads to return to their longer-term historical
averages by early 2011 (although not as tight as they were pre-crisis), which is another factor that will help
boost business investment.
8
Nonetheless, while firms expect sales to grow at a faster pace over the next 12 months than over the past
12 months, they still anticipate that the recovery will be gradual.
The labour market
One of the most important questions for many Canadians is what the coming thaw in
business attitudes will mean for employment. Through the recession, Canada experienced
significant job losses. Some of these jobs are unlikely to come back. Moreover, substantial
slack remains in the labour market in the form of underemployment - for example, people
working part-time who prefer to work full-time. The duration of unemployment has also risen,
which raises understandable concerns. When an individual is out of work, his or her skills
tend to deteriorate, making reintegration into the labour market more difficult. The longer the
period of unemployment, the more difficult it can be for the individual. For the economy as a
whole, this can translate into higher structural unemployment.
As I mentioned earlier, the deterioration in the labour market now appears to have ended,
consistent with the resumption of GDP growth. Both employment levels and average hours
worked bottomed out in the summer, and the unemployment rate has since been hovering
around 8.5 per cent. Against this backdrop, how quickly can the labour market be expected
to improve? Or, could Canada experience a jobless recovery?
Conflicting forces are at play. On the one hand, history suggests that employment growth is
relatively coincident with economic growth in Canada, while improvements in the
unemployment rate lag the cycle, because the more positive economic climate tends to pull
more people back into the labour market.
On the other hand, labour market behaviour has been somewhat unusual during this
recession. Employment held up relatively well, while hours worked fell particularly sharply.
There is some evidence of what economists inelegantly call "labour hoarding" - the retention
of skilled workers even if they may not be immediately needed. This suggests that
employment may grow relatively slowly. Indeed, the Bank's winter Business Outlook Survey
reports that the percentage of firms reporting labour shortages declined further, reaching its
lowest level since the series began in 1998. With the scale of restructuring required, there
may be reluctance to add personnel.
Canada is not the only country with large-scale restructuring. In the United States, the
unemployment rate has jumped sharply, higher than the decline in GDP would have
traditionally suggested, or by about 1 to 1.5 percentage points.9 At 10 per cent, it exceeds
that of Canada - the first time this has occurred since August 1981.10 As in Canada, there is
substantial underemployment and rising long-term unemployment.11 In addition, American
job losses are unusually high in small and medium enterprises (SMEs) while they have been
proportionally lower in Canada, where SMEs have been supported by relatively strong
domestic demand. Unlike Canada, however, U.S. productivity growth has surged, and wage
growth has slowed. The net result is lower unit labour costs, which have boosted
competitiveness and should, ultimately, encourage job creation.
Canada's productivity record is puzzling. The flipside of the apparent labour hoarding is that
Canada's productivity growth fell in the latest recession - something that has not happened
in any recession in the past three decades.12 Moreover, in sharp contrast to the United
States, Canada's productivity performance was abysmal over the decade prior to the
recession.
Some of this undoubtedly reflects the restructuring of industries and the reallocation of
capital and labour to new industries. Some may reflect longer-tailed resources investments.
There remains the possibility that firms have not yet anticipated intensifying global
competitive pressures.
While the Bank does not entirely understand why productivity growth has been as slow as it
has been, we do understand the consequences. Slower productivity growth means that the
rate of potential growth - the speed limit, if you will - of the Canadian economy has fallen.
This has implications for both the growth of Canadian living standards and the conduct of
monetary policy.
To be more specific, the Bank's working hypothesis is that trend labour productivity declined
by 0.2 per cent last year, will rise by only 0.2 per cent this year, and by a still-modest 0.9 per
cent in 2011. The combination of slower productivity growth and demographics could mean
that the rate of potential growth for the Canadian economy will be closer to 2 per cent going
forward than the more than 3 per cent average rate we enjoyed in the first half of the past
decade and the latter half of the 1990s.
If this differential were to persist over a decade, the cumulative loss of income would be
almost $30,000 for every Canadian.13
Inflation outlook
The performance of the labour market and productivity growth will be important influences on
monetary policy going forward. In spite of the large amount of excess supply in the economy,
core inflation has remained quite close to 2 per cent since the beginning of 2009. This
stickiness of core inflation is likely related to the resilience in wage growth relative to the
underlying trend in productivity. Although wage growth in Canada remained high through the
recession, it has decelerated in recent months, causing the gap between wage growth and
measured productivity to begin to narrow. This slower growth in the cost of labour is a factor
that should continue to moderate overall pressures on core consumer price inflation.
With wage growth expected to stay at the more moderate levels seen recently, and with
excess supply being gradually absorbed, both core and total CPI inflation are expected to
return to 2 per cent in the third quarter of 2011. The Bank judges that medium- and
longerterm inflation expectations remain well anchored to the 2 per cent inflation target.
Conclusion
To conclude, recent events were a watershed. The global economy that emerges from the
recession will be different than the one that led into the crisis. A powerful and sustained
restructuring of the global economy has begun. Canadian business will need to develop new
markets as the traditional advantage of relatively open access to U.S. markets becomes less
valuable. To seize new opportunities, our productivity levels must improve.
In the face of these challenges and the ongoing uncertainties about the global outlook, the
credibility of macroeconomic policy is essential. One constant is the Bank's unwavering
commitment to price stability. The single, most direct contribution that monetary policy can
make to sound economic performance is to provide Canadians with confidence that their
money will retain its purchasing power. That means keeping inflation low, stable, and
predictable. Price stability lowers uncertainty, minimizes the costs of inflation, reduces the
cost of capital, and creates an environment in which households and firms can invest and
plan for the future.
13
As expressed in 2009 dollars.