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Chapter 1
Recent Economic Developments and Prospects

Highlights

  • Economic conditions have deteriorated and commodity prices have fallen sharply since the February 2008 budget. This has occurred because of heightened financial market dislocations and a sharp weakening in global demand, led by a significant slowdown in the United States.
  • Private sector forecasters expect real gross domestic product (GDP) growth of 0.6 per cent in 2008 and 0.3 per cent in 2009, well below forecasts at the time of the February 2008 budget. Private sector forecasters are now expecting a technical recession, with negative growth in the fourth quarter of 2008 and the first quarter of 2009.
  • The sharp decline in commodity prices this year is expected to reduce the level of nominal GDP in 2009 and 2010 relative to Budget 2008. However, over the medium term, commodity prices are expected to recover, bringing nominal GDP back to Budget 2008 levels. Nominal GDP is the broadest indicator of the tax base in Canada.
  • There is greater-than-usual uncertainty surrounding the economic outlook. Given the weakness in the U.S. economy and heightened global financial market turmoil, the balance of risks to the Canadian economic outlook is tilted to the downside.
  • Canada is facing this period of global uncertainty from a position of relative strength, reflecting the soundness of Canadian financial institutions and solid financial positions of households, corporations and governments.
  • Canada's strong fiscal situation has allowed the Government to provide significant fiscal stimulus, including broad-based, permanent tax relief and significant investments in infrastructure for the benefit of all Canadians.
  • In 2009–10, Canadians and Canadian businesses will pay $31 billion less in taxes, or almost 2.0 per cent of GDP, as a result of tax reductions implemented by the Government since 2006.
  • Federal funding for provincial-territorial and municipal infrastructure projects in 2009–10 will be double its level in 2007–08.
  • The federal government will work with provinces and territories to expedite infrastructure projects and accelerate the uptake of federal infrastructure funding.
  • Taken together, these permanent tax reductions and infrastructure investments represent a substantial fiscal stimulus.
  • Given the downside risks outlined above and consistent with our Group of Twenty (G20) commitments, the Government will be consulting with Canadians, provinces and territories on further actions to strengthen the economy.

Note: This chapter incorporates data available up to November 21, 2008, unless otherwise indicated. Figures in this chapter are at annual rates unless otherwise noted.

Introduction

In the October 2007 Economic Statement, the Government of Canada put in place almost $60 billion in tax reductions over six years to alleviate the downside risks posed by a weakening U.S. economy and turmoil in financial markets. Over the past year, many of these risks have materialized. Nevertheless, Canada has fared much better than most other industrialized economies. This relatively strong performance reflects the soundness of Canadian financial institutions, the solid financial positions of households, corporations and governments, and the impact of the broad-based, permanent tax reductions put in place since 2006.

This chapter reviews recent economic developments, describes the average private sector economic forecast that forms the basis for the fiscal projections, and discusses the risks and uncertainties associated with this economic outlook. The private sector forecast presented in this chapter was last updated on November 14. However, with the global economic situation remaining fluid, the economic outlook is subject to greater-than-usual uncertainty.

Global Economic Developments and Outlook

The Canadian economy currently faces three major challenges, all of which stem from the external environment. First, ongoing global financial market dislocations have resulted in a significant loss of wealth and much tighter credit conditions. Second, the economic slowdown in the U.S. and other key economies is dampening demand for Canadian exports. And third, prices for many commodities have dropped sharply, which will detract from Canadian profit and income growth.

Global Financial Market Developments

The global financial turmoil, which began in the summer of 2007 following the collapse of the U.S. sub-prime mortgage market, intensified in September and October 2008. The trigger for this renewed turmoil was the failure and near-failure of major financial institutions in the U.S. and Europe, combined with sharply weaker global economic conditions. As a result, liquidity in financial markets dropped sharply, raising banks' financing costs and ultimately increasing the cost and reducing the availability of borrowing for firms and households (Chart 1.1). Together with rising risk aversion, these factors caused stock markets around the world to tumble, with equity prices of financial corporations falling the most (Chart 1.2).

Chart 1.1 – Credit Spreads

Chart 1.2 – World Equity Markets

In Canada, a less-leveraged and better-capitalized banking sector has meant that the increase in borrowing costs and the decline in equity prices of financial institutions have been less pronounced than in other countries. As well, credit growth for Canadian households and businesses has slowed but remains solid, suggesting both stronger demand for and supply of credit in Canada than in other countries.

In reaction to the financial turmoil, governments around the world have announced unprecedented initiatives to stabilize financial markets and restore credit channels. Government actions have taken various forms adapted to the particular circumstances of each country, including the injection of liquidity into many markets, the purchase of assets, increased insurance for bank deposits, guarantees on banks' borrowings, and injections of capital into the banking sector. In line with the Group of Seven (G7) Plan of Action and the Group of Twenty (G20) Summit Declaration, these measures have reduced instability in global financial markets and significantly lowered the risk of a disorderly adjustment.

In Canada, the Government has arranged to purchase up to C$75 billion in insured mortgage pools from Canadian financial institutions through Canada Mortgage and Housing Corporation and has provided a guarantee for banks' borrowings through the Canadian Lenders Assurance Facility. These measures will benefit the Canadian economy by supporting long-term credit availability to Canadians and ensuring that Canadian financial institutions are not put at a competitive disadvantage internationally. Importantly, these actions have been taken on commercial terms and have not put Canadian taxpayers' money at risk.

Recent Global Economic Developments and Outlook

The second major development affecting the Canadian economy is weakening global demand, led by a significant slowdown in the United States. A number of broad economic indicators suggest that the U.S. economy is in recession. Payroll employment has fallen by almost 1.2 million since the beginning of the year, while the unemployment rate has jumped by more than 2 percentage points since mid-2007. U.S. domestic demand remains hamstrung by the effects of the housing market contraction and financial sector turmoil, while consumer confidence has dropped to record lows.

The economic slowdown in the U.S. started with the bursting of the U.S. housing bubble in 2006. Through mid-2007, the main drag on U.S. growth was falling residential investment as rising inventories of unsold homes and falling prices pushed down housing starts (Chart 1.3). Existing home prices are currently down 15 per cent from their level one year ago, an unprecedented rate of decline. Housing starts have plunged 65 per cent from their peak, while the supply of new and existing homes for sale stands at about 10 months, near a record high.

Chart 1.3 – U.S. Housing Starts and Inventories / Growth in U.S. Existing Home Prices

Through most of 2007, the drag from residential investment was offset by robust growth in U.S. consumption and exports (Chart 1.4). However, the pace of consumer spending slowed sharply at the end of 2007. This slowing in U.S. consumer spending was temporarily masked by the positive boost provided by the fiscal stimulus plan introduced in early 2008. This plan, the Economic Stimulus Act, provided temporary tax relief equivalent to about 1 per cent of the U.S. economy, largely through income tax rebates to households. The economic boost from the U.S. stimulus package was particularly evident in the second quarter of 2008. Since June, however, the temporary effect of the tax rebate has receded and consumer spending has contracted sharply. Combined with another double-digit decline in residential construction and weaker business investment spending, this led to a 0.3 per cent contraction of overall GDP in the third quarter of 2008.

In response to rising financial market distress and the weakening economy, the Federal Reserve has lowered the target for the fed funds rate by 425 basis points since September 2007. The Federal Reserve and central banks around the world, including the Bank of Canada, have also continued to take extraordinary measures to inject liquidity to support the functioning of financial markets.

Chart 1.4 – Contributions to U.S. Real GDP Growth / U.S. Real Net Exports

Looking ahead, private sector forecasters expect U.S. real GDP to grow by 1.4 per cent in 2008 and to decline by 0.4 per cent in 2009, before strengthening to 2.1 per cent in 2010. Relative to forecasts prepared at the time of Budget 2008, U.S. economic growth has been revised down by 2.8 percentage points in 2009 and 0.9 percentage points in 2010.

The current recession in the U.S. is expected to be similar to the 1990 recession and considerably more severe than the 2001 recession that followed the bursting of the high tech bubble (Chart 1.5).

Given the rapidly evolving global financial and economic situation, the International Monetary Fund (IMF), in its November 2008 World Economic Outlook Update, has also revised down its forecast for the United States (Chart 1.6). The IMF is now forecasting the U.S. economy to contract by 0.7 per cent in 2009.

Chart 1.5 – U.S. Real GDP Growth Outlook in Historical Perspective

The IMF now expects world real GDP growth to slow sharply from 5.0 per cent in 2007 to 3.7 per cent in 2008 and 2.2 per cent in 2009.[1] The projected growth for 2009 would be the weakest since 1993. In advanced economies, output is projected to contract in 2009, the first year-over-year fall in output in the postwar period. The IMF now projects a contraction of output in all G7 economies except Canada in 2009.

The sharp slowdown in global economic activity and the associated drop in energy and other commodity prices have reduced global inflationary pressures. The IMF projects overall consumer price inflation in advanced economies to ease to below 1.5 per cent by the end of 2009 from an average of 3.6 per cent in 2008.

Chart 1.6 – World Real GDP Growth Outlook

The Euro area has entered a technical recession. Economic activity contracted modestly in the second and third quarters of 2008, led by declines in Germany and Italy. Looking ahead, tighter credit conditions, falling confidence and slower export growth are expected to continue to weigh on growth in the Euro area. After rising by 2.6 per cent in 2007, the IMF projects Euro area economic activity to grow by 1.2 per cent in 2008, but then to contract by 0.5 per cent in 2009.

Japan has also entered a technical recession. For the second consecutive quarter, real GDP contracted in the third quarter, reflecting declines in fixed investment and net exports as well as weak household spending. Recent indicators point to growing weakness ahead, reflecting weaker external and domestic demand. Economic growth in Japan is expected to slow from 2.1 per cent in 2007 to 0.5 per cent in 2008 and then turn negative in 2009 at -0.2 per cent.

In China, real GDP growth slowed to 9 per cent year over year in the third quarter of 2008, its slowest pace since 2003. Growth in other emerging economies has also eased, although most are still experiencing solid growth. The moderation of economic activity in China and other emerging economies largely reflects slower export growth. The IMF projects growth in emerging and developing economies to slow from 8 per cent in 2007 to 6.6 per cent in 2008 and 5.1 per cent in 2009, which includes growth in China of 11.9 per cent in 2007, 9.7 per cent in 2008 and 8.5 per cent in 2009. This forecast does not incorporate the impacts of China's recently announced two-year fiscal stimulus package.

Commodity Prices

The third global development affecting the Canadian economy is the recent fall in commodity prices. In the first half of 2008, commodity prices increased sharply, reaching record highs (Chart 1.7).

However, since July, commodity prices have fallen sharply, reflecting much weaker growth in demand in advanced economies. The decline has been broad-based, affecting virtually all commodities produced in Canada, particularly energy. The price of crude oil (West Texas Intermediate) has dropped by more than 60 per cent from its record closing high of US$145.66 per barrel reached on July 11. Crude oil closed as low as US$49 per barrel on November 20, its lowest level since mid-2005. The slump in oil prices has continued despite the late-October announcement by the Organization of the Petroleum Exporting Countries (OPEC) to cut production. Natural gas prices have also declined significantly, despite production disruptions in the Gulf of Mexico following hurricanes Gustav and Ike. Although the Budget 2008 assumptions for energy prices were prudent, energy prices are now about 40 per cent below levels assumed at that time.

Chart 1.7 – Commodity Prices (in U.S. Dollars) / Change in Commodity Prices (in U.S. Dollars)–July to November 2008

Non-energy commodity prices have weakened by more than 20 per cent since July, reflecting broad-based declines for most commodities. The decline in non-energy commodity prices is significant given that these commodities account for about half of Canadian commodity production.

In the past six years, rising commodity prices have raised living standards in Canada. The run-up in commodity prices since early 2002, in tandem with the appreciation of the Canadian dollar, has translated into a sharp increase in Canada's export prices relative to import prices—the terms of trade. This gain, along with rising output, has boosted real gross domestic income by over 17 per cent since 2001 (Chart 1.8).

The recent sharp decline in commodity prices over the past several months means that Canada's terms of trade are now falling, which will reduce the value of goods produced and exported by Canada in the short term. However, the increase in real gross domestic income since 2001 remains substantial, particularly in relation to gains in the United States.

Chart 1.8 – Cumulative Growth in Real Gross Domestic Income per Capita Since 2001

The collapse in commodity prices will also translate into a deterioration in the country's current account balance—the sum of Canada's balance of international trade and net income and transfers from abroad—which has been in surplus since mid-1999. A deterioration of Canada's current account balance will also lead to a modest rise in our net foreign indebtedness as a share of GDP over the near term. Nevertheless, Canada's foreign indebtedness has declined substantially over the past 15 years and is still expected to remain near record lows even in the event of a temporary current account deficit (Chart 1.9).

Chart 1.9 – Current Account Balance / Net Foreign Debt

Canadian Economic Developments

The U.S. economic slowdown, ongoing global financial market turbulence and lower commodity prices have dampened output and income growth in Canada. In addition, the risks to the outlook are tilted to the downside. However, the Canadian economy has a number of core strengths that will help the country manage during the global economic slowdown.

Slower Growth

Over the past four quarters, output growth in Canada has averaged just 0.7 per cent, primarily because exports have declined in response to the U.S. slowdown and a high Canadian dollar. In contrast, final domestic demand has continued to grow, supported by the solid financial positions of both households and businesses (Chart 1.10).

Chart 1.10 – Real GDP Growth / Real Final Domestic Demand and Export Growth

More recently, the turmoil in global financial markets has begun to weigh on domestic demand in Canada. In particular, growth in personal consumption has slowed and consumer confidence has fallen to its lowest level in nearly 13 years (Chart 1.11). Nevertheless, the decline in consumer confidence in Canada has been much less pronounced than in the U.S.

Canadian housing investment fell in the first half of 2008, following a period of rapid growth from 2002 to 2007. Despite the recent downturn, housing activity has been solid, with housing starts so far in 2008 well above the average over the previous 30 years of 179,000 units. This high level of activity has been supported by strong real income gains over the past six years, strong household financial positions and historically low interest rates (see the box entitled "Canadian Housing Market Developments").

Chart 1.11 – Real Personal Consumption Growth / Consumer Confidence

Following five consecutive years of strong growth, business investment growth slowed in the first two quarters of 2008 due to tighter credit conditions and a weaker economic outlook (Chart 1.12). The slowdown was particularly evident in machinery and equipment (M&E) investment, which was supported in 2007 by lower prices of imported M&E due to the past appreciation of the Canadian dollar. The temporary accelerated capital cost allowance treatment for M&E used in the manufacturing and processing sector, introduced in Budget 2007 and extended in Budget 2008, will continue to provide an incentive for businesses to increase capital investment. This will assist the manufacturing and processing sector in restructuring to meet current economic challenges and to increase its long-term prospects, by encouraging the retooling needed to boost productivity and move to higher value-added production.

Chart 1.12 – Real Business Non-Residential Investment Growth

The appreciation of the Canadian dollar up to last fall and the U.S. slowdown have affected export-intensive sectors, particularly the manufacturing and forestry-related sectors (Chart 1.13). Approximately 75 per cent of Canadian manufacturing production is located in central Canada, and more than 80 per cent of central Canada's manufacturing exports are shipped to the United States. Since the beginning of 2006, real output in the manufacturing sector has declined by close to 7 per cent, due largely to a decline of nearly 24 per cent in the motor vehicle and parts manufacturing industry. The auto industry has been particularly affected by a sharp decline in U.S. demand for automobiles—as about 90 per cent of vehicles produced in Canada are exported to the U.S.—and the ongoing restructuring of the North American auto industry. The forestry-related sectors have also been adversely affected by global restructuring and very weak U.S. housing demand. Real output in the pulp and paper industry has declined by 16 per cent since the beginning of 2006 while the forestry sector and wood product manufacturing industry have registered a decline of about 30 per cent.

Recognizing the challenges faced by these sectors, the Government has acted to support these industries and their workers. In January 2008, it announced the establishment of the Community Development Trust, which will provide up to $1 billion for provincial and territorial initiatives over its three-year lifespan to assist workers and communities that are experiencing hardship due to international economic volatility, through activities such as job training, community transition plans and infrastructure investments. In Budget 2008, the Government introduced the Automotive Innovation Fund, which is providing $250 million over five years to support strategic, large-scale research and development projects in the automotive sector to develop innovative, greener and more fuel-efficient vehicles.

The Government is taking further action in this Economic and Fiscal Statement by ensuring that Export Development Canada and the Business Development Bank of Canada are increasing credit to export-oriented manufacturing enterprises, including automotive producers, and to small and medium-sized enterprises to mitigate the effect of the global credit crisis on their operations (see Chapter 2). Furthermore, the recent depreciation of the Canadian dollar and the sharp decline in commodity prices will help manufacturing enterprises going forward.

Chart 1.13 – Real GDP Growth by Sector

Canadian Housing Market Developments

Canadian housing market activity has recently begun to slow, following a prolonged period of rapid growth. From 2002 to 2007, housing starts in Canada were well in excess of the 30-year historical average of 179,000 units (Chart 1.14). This boom was the result of an unwinding of pent-up demand triggered by strong income growth and low interest rates. Housing prices in Canada only began to increase in 1999 following a 10-year period of weakness. As a result, the average annual increase in home prices has been fairly modest (3.4 per cent) over the last 20 years.

Chart 1.14 – Housing Starts / Existing Home Prices

Unlike in the U.S., the rebound in the Canadian housing market was not fuelled by the sub-prime market and significant off-balance-sheet funding. At its peak in 2006, the sub-prime market accounted for 22 per cent of all new mortgage originations in the U.S. compared to less than 5 per cent in Canada.

Indeed, none of the conditions that led to the U.S. housing and financial market collapse are present in Canada. In addition:

  • Household net wealth in the second quarter was 6.3 times higher than disposable income in Canada—near a record high and significantly above the U.S. factor of 5.2. Recent stock market declines will reduce net worth as a share of income, but it will remain high both historically and relative to the United States.
  • Mortgage interest payments as a share of disposable income remain close to historical lows in Canada, while they have risen to record highs in the United States.
  • Canadian households have very high equity positions in their homes. Mortgage debt has declined to about 30 per cent of the value of housing in Canada, while in the U.S. it has risen to a record 55 per cent of the total value of housing.

These divergent trends have resulted in the share of mortgages in arrears remaining near historic lows in Canada but rising to record highs in the United States (Chart 1.15). Reflecting these fundamental differences, the U.S. housing market is in the midst of a severe housing correction. In contrast, the Canadian housing market has entered a cyclical slowing in prices and activity. In this context, we should continue to see moderate increases in inventories of unsold houses and downward adjustments in prices. However, the sharp increase in foreclosure rates witnessed in the U.S. should not occur in Canada. Regionally, the housing boom was led by the western provinces, reflecting particularly strong gains in net migration, employment and income growth in these provinces. Consequently, the current slowdown has been most marked in these provinces as well.

Chart 1.15 – Share of Mortgages in 90-Day Arrears

Canada's Economic Strengths

Despite the sharp slowdown in growth described above, economic conditions in Canada are favourable compared to those in most other countries. This is true of a broad range of indicators including consumption, investment and employment (Chart 1.16). These developments reflect a number of core strengths:

  • The financial positions of households and businesses remain solid, both historically and compared to the United States (Chart 1.17). Recent stock market declines will reduce net worth as a share of income, but it will remain high both historically and relative to the United States.
  • The Canadian housing sector is sound (see the box entitled "Canadian Housing Market Developments").
  • Canada's banks and other financial institutions are sound and well capitalized, and have lower leverage ratios than their international peers (Chart 1.18).
  • Core Consumer Price Index (CPI) inflation has remained low, stable and predictable and is well within the Bank of Canada's inflation target band. As well, total inflation is lower in Canada than in other countries, as the reduction in the goods and services tax rate and the past appreciation of the Canadian dollar (which lowered prices for imported goods) have offset to a large extent the impact of higher energy and food prices for Canadian families this year (Chart 1.19). Going forward, the sharp drop in energy prices since the summer will provide further relief to Canadian consumers.
  • Canada has maintained the best fiscal position of all G7 countries.

Chart 1.16 – Growth in Employment

Chart 1.17 – Household Net Worth / Corporate Profits

Chart 1.18 – Bank Leverage Ratios

Chart 1.19 – Total CPI Inflation

Fiscal Stimulus

Canada's strong fiscal situation has allowed the Government to provide significant, broad-based, permanent tax relief and make targeted, growth-enhancing investments in infrastructure for the benefit of all Canadians.

These measures will provide a substantial fiscal stimulus to the Canadian economy through the global slowdown, and will help strengthen our economy for the long term.

The tax reduction measures implemented by the Government since 2006 mean that in 2009–10, Canadians and Canadian businesses will pay $31 billion less in taxes—the equivalent of nearly 2 per cent of GDP.

Building on the significant measures implemented last year at the onset of the global slowdown, some of these tax reductions are coming into force in 2009:

  • The amount that every individual can earn without paying federal income tax will rise from $9,600 in 2008 to $10,100 in 2009.
  • Effective January 1, 2009, Canadians will be able to benefit from the new Tax-Free Savings Account, a flexible, registered general-purpose account that will allow Canadians to earn tax-free investment income and encourage savings and investment.
  • Corporations will also benefit from a reduction in the general corporate income tax rate, which will fall from 19.5 per cent to 19 per\ cent on January 1, 2009 and is legislated to fall to 15 per cent by 2012.

Canadians will continue to benefit in the coming years from federal tax relief that is permanent and sustainable—unlike the temporary approach to tax relief taken in other countries such as the United States (Chart 1.20).

Provinces have also taken steps to reduce taxes. Several provinces have responded favourably to the temporary financial incentive introduced in Budget 2007 to eliminate their capital taxes. By 2012, all provincial general capital taxes will have been eliminated. Some provinces are also reducing personal and corporate income tax rates. Total tax relief announced by provincial governments since 2006 amounts to $8.6 billion or 0.5 per cent of GDP for 2009–10.

Chart 1.20 – Federal Tax Stimulus Since 2006

Reflecting measures taken to restore fiscal balance, the federal government is also making historic increases in the funding available for infrastructure projects. In Budget 2007, the Government announced a seven-year $33-billion plan to boost Canada's public infrastructure projects such as roads and highways, public transit, bridges, sewers and water systems. The amount of federal funding available for provincial-territorial and municipal infrastructure projects rose by 40 per cent in 2008–09 and will rise a further 40 per cent in 2009–10, hitting a record of $6 billion in that year, or double the amount spent in 2007–08 (Chart 1.21). At the recent First Ministers Meeting, federal, provincial and territorial governments agreed to work together to expedite infrastructure projects and accelerate the uptake of federal infrastructure funding.

Taken together, these tax reductions and infrastructure investments represent a substantial fiscal stimulus. These measures represent timely and appropriate actions that respond to Canada's current economic challenges and that will help strengthen Canada's economy for the long term.

Chart 1.21 – Federal Funding Provided to Provinces, Territories and Municipalities for Infrastructure

Private Sector Canadian Outlook

The Department of Finance surveys private sector economic forecasters on a quarterly basis for their outlook of the Canadian economy. The economic forecasts presented here incorporate economic data through the first half of November 2008. The average of private sector forecasts form the basis for economic assumptions that underlie the fiscal projections reported in Chapter 3.

Private sector forecasters anticipate real GDP growth of 0.6 per cent in 2008, down from 1.7 per cent expected at the time of the February 2008 budget (Chart 1.22 and Table 1.1). Looking ahead, forecasters expect growth to continue to remain weak at 0.3 per cent in 2009, down from 2.4 per cent predicted at the time of the budget, reflecting expectations of slower U.S. growth and the anticipated negative effects of the global financial turmoil. This would mark the weakest two-year average real GDP growth in Canada since the early 1990s.

Chart 1.22 – Real GDP Growth Outlook / Nominal GDP Growth Outlook

Private sector forecasters expect nominal GDP to grow by 4.4 per cent in 2008, up from 3.5 per cent anticipated at the time of the budget. However, forecasters expect nominal GDP growth to slow to 0.8 per cent in 2009, significantly lower than expected in the budget, reflecting weak real GDP growth and significantly reduced GDP inflation as a result of falling commodity prices. The level of nominal GDP in 2008 is expected to be $13 billion higher than anticipated at the time of the budget. However, it is expected to be $43 billion lower in 2009 and $50 billion lower in 2010 than anticipated at the time of the budget.

On a quarterly basis, private sector forecasters expect the U.S. economy to remain in recession until mid-2009, with a significant downturn in the last quarter of 2008. Recent economic indicators suggest that Canadian real GDP grew by about three quarters of a per cent in the third quarter, assuming a modest inventory accumulation. This is broadly similar to the average private sector forecast for the third quarter. The Canadian economy is expected to experience a technical recession in late 2008 and early 2009. Real GDP is expected to contract by 1.0 per cent in the fourth quarter of 2008 and by 0.4 per cent in the first quarter of 2009 in Canada, compared to larger declines of 2.5 per cent and 1.4 per cent in the United States (Chart 1.23).

Chart 1.23 – Real GDP Growth Outlook

Private sector forecasters expect Canadian labour markets to stay relatively healthy despite the weaker economic outlook. The unemployment rate is expected to average 6.1 per cent in 2008, 6.9 per cent in 2009 and 6.7 per cent in 2010. In comparison to past cycles, the rise in the unemployment rate in the current period is expected to be modest (Chart 1.24). These forecasts indicate that the Employment Insurance break-even premium rate for 2009 would have risen. Nevertheless, the Government of Canada will hold the rate for 2009 unchanged at $1.73, its lowest level in 15 years. Starting next fall, the Employment Insurance rate will be set based on the recommendations of the new Canada Employment Insurance Financing Board.

Private sector forecasters expect Canadian short-term interest rates to average 2.4 per cent in 2008, lower than the 3.2 per cent expected in the budget forecast. Looking forward, forecasters project that short-term rates will average 1.9 per cent in 2009 and 2.7 per cent in 2010, which are both significantly lower than expected at the time of the budget.

Long-term interest rates in 2008 are expected to be just above the budget forecast at 3.7 per cent. At the time of the budget, private sector forecasters expected long-term rates to rise significantly in 2009 and 2010. Projections are now more modest with long-term rates expected to be 3.7 per cent in 2009 and 4.2 per cent in 2010.

Chart 1.24 – Unemployment Rate

Private sector forecasters expect total CPI inflation to reach 2.6 per cent in 2008, almost double the rate expected at the time of the budget. However, forecasters see inflation returning to 1.7 per cent in 2009 and 1.9 per cent in 2010, modestly below the budget projections. The Canada-U.S. exchange rate is expected to reach 89 U.S. cents by 2010, supported by a modest recovery in commodity prices, with oil prices rising to US$79 per barrel by 2010.

Overall, private sector forecasters have not significantly altered their medium-term economic outlook since Budget 2008. The main exception is GDP inflation, which is expected to average 2.2 per cent over the medium term, compared to 1.6 per cent projected at the time of the budget. This largely reflects higher-than-anticipated terms-of-trade gains due to somewhat higher commodity prices than expected at the time of the budget. As a result, private sector forecasters expect nominal GDP to grow by an average annual rate of 5.1 per cent from 2011 to 2013, compared to 4.2 per cent in Budget 2008.

Table 1.1
Average Private Sector Forecasts


        Average
  2008 2009 2010 2011–13

  (per cent, unless otherwise indicated)
Real GDP growth        
February 2008 budget 1.7 2.4 2.9 2.6
November 2008 Economic and Fiscal Statement 0.6 0.3 2.6 2.9
GDP inflation        
February 2008 budget 1.8 1.9 1.8 1.6
November 2008 Economic and Fiscal Statement 3.8 0.5 1.8 2.2
Nominal GDP growth        
February 2008 budget 3.5 4.3 4.7 4.2
November 2008 Economic and Fiscal Statement 4.4 0.8 4.4 5.1
Nominal GDP level (billions of dollars)        
February 2008 budget1 1,590 1,659 1,738 1,890
November 2008 Economic and Fiscal Statement 1,603 1,615 1,687 1,870
3-month treasury bill rate        
February 2008 budget 3.2 3.8 4.5 4.5
November 2008 Economic and Fiscal Statement 2.4 1.9 2.7 4.2
10-year government bond rate        
February 2008 budget 3.6 4.2 4.8 5.0
November 2008 Economic and Fiscal Statement 3.7 3.7 4.2 5.0
Consumer Price Index (CPI) inflation        
February 2008 budget 1.5 1.9 2.0 2.1
November 2008 Economic and Fiscal Statement 2.6 1.7 1.9 2.1
Oil price level (US dollars per barrel)        
February 2008 budget 82.1 79.8 82.3 77.5
November 2008 Economic and Fiscal Statement 102.5 72.0 79.0 91.1
Exchange rate (US cents/C$)        
February 2008 budget 98.0 95.5 95.5 96.2
November 2008 Economic and Fiscal Statement 94.9 85.6 88.7 95.8
Unemployment rate        
February 2008 budget 6.3 6.4 6.2 6.0
November 2008 Economic and Fiscal Statement 6.1 6.9 6.7 6.2
U.S. real GDP growth        
February 2008 budget 1.5 2.4 3.0 2.7
November 2008 Economic and Fiscal Statement 1.4 -0.4 2.1 3.0

1 Nominal GDP levels have been adjusted to reflect 2008 revisions to Canada's National Income and Expenditure Accounts.
Source: Department of Finance survey of private sector forecasters.

Risks and Uncertainties

Given the ongoing weakness of the U.S. economy and heightened global financial market turmoil, risks to the Canadian outlook are mainly tilted to the downside. The main risks stem from continued volatility in global financial markets, which has resulted in tighter global credit conditions and exacerbated the economic downturn in the U.S. and the rest of the world. Indeed, global financial markets continue to experience extreme volatility, and there is uncertainty as to when and at what level they will stabilize. There is the risk that global credit conditions could tighten further, which could spill over into Canada through higher costs of financing and tighter lending standards.

Given these developments, there is also the risk that a prolonged period of tight credit conditions and market volatility could lead to significantly weaker domestic demand in the United States and globally. A weaker U.S. and global outlook would reduce demand for Canadian manufactured products and Canadian commodities. Volatile financial markets and a prolonged downturn in U.S. and global economic growth would further reduce demand for commodities from Canada and around the world, and maintain downward pressure on commodity prices.

The range of private sector forecasts highlights the higher-than-usual risks and uncertainty surrounding the economic outlook. While private sector forecasters expect real GDP to grow by 0.3 per cent on average in 2009, there is a large range around this forecast, with the lowest forecast calling for negative growth of 0.7 per cent, and the highest calling for 1.0 per cent growth in 2009. The current IMF economic forecast for Canada is identical to the private sector average at 0.3 per cent while the OECD forecast is at the low end of this range at -0.5 per cent.

With respect to nominal GDP growth in 2009, the range is even higher. Given the uncertainty in the global economy at the moment, private sector forecasters have a wide range of nominal GDP growth forecasts for 2009 from as low as -2.5 per cent to as high as 2.5 per cent.

Chart 1.25 shows the difference between the average of the two highest and two lowest one-year-ahead forecasts for real and nominal GDP growth in the Economic and Fiscal Updates and Statements since 2005. This chart suggests that the risks and uncertainty currently surrounding the economic outlook are larger than they have been for some time. The implications of this uncertainty for the fiscal outlook are discussed in Chapter 2.

Chart 1.25 – Range of One-Year-Ahead Economic Forecasts in Economic and Fiscal Updates and Statements Since 2005


1 The IMF reports world real GDP growth on both a purchasing power parity and a market exchange rate basis. On a market exchange rate basis, the IMF expects world real GDP growth to ease from 3.7 per cent in 2007 to 2.6 per cent in 2008 and 1.1 per cent in 2009. [Return]

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