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2. Economic Developments and Prospects


The Canadian economy has fared much better than other major advanced economies throughout the recession and over the recovery to date. The decline in GDP during the global recession was the smallest of all G-7 countries, and with the economic recovery now underway in Canada, both economic activity and private domestic demand have virtually returned to pre-crisis levels. Canada’s strong economic performance reflects the significant stimulus provided by Canada’s Economic Action Plan together with monetary easing over the recession and Canada’s solid economic fundamentals.

Going forward, private sector economists expect that economic growth in Canada will continue to be moderate. Real GDP growth is expected to be 1.8 per cent in the third quarter of 2010 followed by growth of about 2.5 per cent over the next three quarters.

The global economy continues to recover from the deepest and most synchronized global recession since the 1930s, supported by significant policy stimulus. The global recovery has been led by emerging and developing economies, particularly in Asia. In contrast, the recovery has been more moderate in many advanced economies, where ongoing balance sheet adjustments are restraining growth in private domestic activity.

Uncertainty surrounding the global economic outlook remains elevated and the balance of risks is tilted to the downside, particularly in the near term. In light of the downside risks to the economic outlook, the average private sector forecast for nominal GDP is adjusted downward for fiscal planning purposes.

This section reviews the major global and Canadian economic developments since Budget 2010, describes the private sector economic forecast that forms the basis for the medium-term fiscal projections included in this report, and discusses the risks surrounding the economic outlook.

Global Economic Developments and Outlook

In late 2009 and early 2010, the pace of the global recovery was stronger than had been expected but it has varied significantly across countries. The recovery is expected to continue, albeit at a moderate pace, and significant risks to the global outlook remain.

Economic growth over the recovery to date has been modest in most advanced economies, particularly when compared to past recoveries. In contrast, many emerging and developing economies, particularly in emerging Asia, are experiencing strong growth.

The recovery in advanced economies is expected to remain modest, reflecting the expected gradual easing of fiscal stimulus in coming quarters and the end of the inventory rebuilding cycle. In this context, a sustained global recovery will require increased support from private sector spending. While there have been positive signs in some advanced countries, where private domestic demand strengthened in the second quarter of 2010 (Chart 2.1), low consumer confidence, continued weakness in household and financial sector balance sheets and high unemployment will weigh on private domestic demand growth in many advanced economies going forward.

Private domestic demand has strengthened in some advanced economies
Chart 2.1 - Real Private Domestic Demand Growth

Overall, the IMF expects global economic activity to grow by 4.8 per cent in 2010 and 4.2 per cent in 2011, led by developing Asian countries including China (Chart 2.2). In advanced economies the ongoing recovery is expected to be more modest with growth of 2.7 per cent expected in 2010 and 2.2 per cent in 2011.

A modest economic recovery is expected to continue, particularly in advanced economies
Chart 2.2 - IMF World Real GDP Growth Outlook

In the U.S., the National Bureau of Economic Research declared that the U.S. economic recession ended in June 2009. However, the U.S. recovery has been weak by historical standards, especially considering the severity of the recession. The modest recovery has mostly been supported by policy stimulus and the end of the inventory liquidation cycle, the effects of which are currently fading.

With the resumption of economic growth, U.S. firms have cautiously resumed hiring with the creation of almost 900,000 jobs in the private sector since the end of 2009 (Chart 2.3). However, the U.S. unemployment rate remains near a 27-year high and payroll employment remains nearly 7.8 million (or 5.6 per cent) below its pre-recession peak. Persistent unemployment and ongoing balance sheet adjustments have meant that growth in private domestic activity, particularly consumer spending, has remained weak.

U.S. employment has started to recover but remains weak
Chart 2.3 - U.S. Payroll Employment

U.S. real GDP increased by 1.71 per cent in the second quarter of 2010, following two quarters of unexpectedly strong growth owing mainly to the impact of policy stimulus and a large boost from inventory investment (Chart 2.4). Private sector forecasters expect growth in the U.S. to remain moderate over the second half of 2010 and the first half of 2011 as these factors continue to wane. Overall, they expect U.S. real GDP growth to average 2.7 per cent in 2010 and 2.4 per cent in 2011. Continued high unemployment, together with ongoing deleveraging by households and financial institutions and high and rising public debt, suggest that the U.S. recovery will remain moderate over the medium term.

U.S. economic growth is expected to continue to be moderate
Chart 2.4 - U.S. Real GDP Growth Outlook

Canadian Recent Economic Developments

The Canadian economy continues to recover from the deepest global recession since the 1930s. Canada weathered the global recession better than most other industrialized countries and has experienced a solid recovery. As of the second quarter, Canada is the only G-7 country to have virtually recouped the output lost over the recession. Canada is also the only G-7 country to have posted significant employment growth since June 2009.

Canada’s continued financial, economic and fiscal strengths, together with substantial support provided by the Economic Action Plan and monetary policy, allowed Canada to weather the global recession better than most other industrialized countries. Indeed, the recession in Canada was less pronounced than in any other G-7 economy (Chart 2.5).

Canada fared better than all other G-7 countries during the global recession
Chart 2.5 - Overall Contraction in Real GDP During the Recession

The Canadian economy has expanded for four consecutive quarters, after returning to growth in the third quarter of 2009 (Chart 2.6). Following strong growth of 4.9 per cent in the fourth quarter of 2009 and 5.8 per cent in the first quarter of 2010, real GDP increased by 2.0 per cent in the second quarter of 2010. The moderation in growth in the second quarter partly reflected an easing in spending of households, particularly housing investment. Housing activity had been strong at the end of 2009 and early 2010, partly reflecting a number of transitory factors, and was widely expected to ease in the second half of 2010.

As a result of Canada’s stronger economic performance both during the recession and over the recovery, economic output has now virtually returned to pre-recession levels. Canada is the only G-7 country to have nearly recouped the output lost since the start of the recession.

An economic recovery is underway in Canada
Chart 2.6 - Real GDP Growth

The recovery in output has led to a recovery in jobs in Canada. All of the jobs lost during the recession in Canada have now been recouped, with nearly 423,000 jobs created since July 2009, which represents the trough in national employment. As a result of strong job creation, the unemployment rate in Canada fell from a peak of 8.7 per cent in August 2009 to 8.0 per cent in September 2010. This is significantly better than what private sector economists were expecting early in the recession. In early 2009, some private sector economists were forecasting that the unemployment rate would peak at as high as 10 per cent.

The labour market recovery in Canada contrasts sharply with labour market developments in the United States, where employment remains well below pre-recession levels. The U.S. unemployment rate, at 9.6 per cent, is near a 27-year high and remains well above the Canadian unemployment rate—a phenomenon not seen in nearly three decades. Canada’s labour market has also performed better than its G-7 peers, with Canada being the only G-7 country to have posted significant employment growth since June 2009 (Chart 2.7).

The Canadian labour market has been much stronger than in any other G-7 country
Chart 2.7 - Change in Total Employment From June 2009 to June 2010

Reflecting the positive impact of the Economic Action Plan on consumer and business confidence, the economic recovery has been underpinned by a strong rebound in private domestic demand—the sum of consumer and business expenditures (Chart 2.8). As a result, Canada has experienced the strongest recovery in private domestic demand in the G-7 (Chart 2.9).

A rebound in private domestic demand has underpinned the economic recovery
Chart 2.8 - Real Private Domestic Demand Growth


Canada has experienced the strongest recovery in private domestic demand in the G-7
Chart 2.9 - Real Private Domestic Demand Growth From 2009Q2 to 2010Q2

Canada’s solid economic performance reflects the positive impacts of significant and timely policy stimulus, including the support provided by Canada’s Economic Action Plan, as well as several important strengths.

In particular, Canada’s financial institutions were better capitalized and less leveraged than their international counterparts going into the global recession. They continue to be regarded as the healthiest in the world. Indeed, the World Economic Forum has ranked Canada’s banking system as the soundest in the world for three consecutive years. Additionally, Canada responded to the crisis from a position of strength and emerged from the recession stronger than many other advanced countries, reflecting strong corporate and household balance sheets, the ongoing impact of previous broad-based tax reductions and a solid fiscal position. Indeed, Canada was the only G-7 country to consistently post budget surpluses in the years leading up to the global recession (Chart 2.10).

Canada entered the global recession with the strongest fiscal position in the G-7
Chart 2.10 - Total Government Fiscal Balances in 2007

Financial Market Developments

Global financial conditions have improved considerably since the global financial crisis of late 2008 and early 2009, reflecting the impact of measures undertaken worldwide. Borrowing costs for banks and corporations declined markedly through 2009 to just above pre-crisis levels (Chart 2.11). This has translated into a significant improvement in global economic activity.

Financial market conditions have improved markedly since early 2009
Chart 2.11 - Short-Term Financing Spreads / Long-Term Corporate Spreads

Earlier this year, financial markets became increasingly concerned about the sustainability of public finances in a number of European countries. This raised borrowing costs for those economies, and resulted in considerable financial market volatility globally. Although this volatility has eased in recent months as these countries have taken important steps to restore fiscal sustainability over the medium term, considerable uncertainty remains. These developments underscore the fragile nature of global financial conditions.

In Canada, the financial crisis had considerably less impact than in other countries, leaving borrowing costs relatively low and credit growth solid. At the same time, the recovery in the world prices of most commodities produced in Canada, together with Canada’s sound fundamentals, has boosted the attractiveness of Canadian financial assets among international investors, keeping bond rates low and supporting the Canadian dollar.

Commodity Prices

World prices for the major commodities produced in Canada have rebounded significantly from lows observed in early 2009 and remain, on average, largely unchanged since the start of the year (Chart 2.12). Non-energy commodity prices, in general, have increased significantly, led by strong increases in precious metals prices, as increased investor risk aversion has strongly supported demand, leaving gold prices at record highs. Gains have also been seen in agricultural commodity prices, mainly as a result of weather-driven supply factors, while some signs of stabilization in U.S. housing markets have provided support to forest product prices.

Prices for Canadian commodities overall are roughly unchanged since the start of the year
Chart 2.12 - Comodity Prices (in U.S. dollars) / Change in Commodity Prices (in U.S. dollars) From January 2010 to September 2010

Energy prices, however, have retreated modestly since the start of the year, but remain at levels well above those seen in early 2009. Natural gas prices have declined, in part on indications that increased shale gas supply in the United States has greatly increased the recoverable reserves of that country. This has been partly offset by a modest increase in oil prices in response to the recovery in the global economy. Current futures contracts suggest that financial markets expect a gradual increase in crude oil and natural gas prices over the next five years as the economic recovery continues.

Private Sector Canadian Outlook

The Department of Finance regularly surveys private sector economic forecasters on their views on the outlook for the Canadian economy. The economic forecast presented in this section is based on a survey conducted in September 2010, and includes the views of 15 private sector forecasters.

The September 2010 survey of private sector forecasters included Bank of America Merrill Lynch, BMO Capital Markets, Caisse de dépôt et placement du Québec, CIBC World Markets, The Conference Board of Canada, Desjardins, Deutsche Bank of Canada, IHS Global Insight, Laurentian Bank Securities, National Bank Financial Group, Royal Bank of Canada, Scotiabank, TD Bank Financial Group, UBS Securities Canada, and the University of Toronto (Policy and Economic Analysis Program).

In the fourth quarter of 2009 and the first quarter of 2010, real GDP growth came in significantly higher than was expected by private sector forecasters at the time of the March 2010 budget (Chart 2.13). However, growth in the second quarter of 2010 came in weaker than was expected in the budget. Private sector forecasters now expect real GDP growth of 1.8 per cent in the third quarter of 2010 and 2.5 per cent in the fourth quarter. Growth is expected to remain moderate through the first half of 2011.

On balance, the overall result in the September 2010 survey of private sector forecasters is that over the next five years, the path of nominal GDP, which is the broadest measure of the tax base, is broadly in line with the planning assumptions in Budget 2010.

Real GDP growth is expected to remain moderate in the near term
Chart 2.13 - Canadian Real GDP Growth Outlook

The economic forecast in the September 2010 survey is consistent with the current IMF projections for Canada. Both the IMF and the Organisation for Economic Co-operation and Development expect Canada to have the strongest average economic growth in the G-7 over the next two years (Chart 2.14).

Canada is expected to have the strongest average economic growth among G-7 countries over the next two years
Chart 2.14 - IMF Outlook for Real GDP Growth in G-7 Countries for 2010 and 2011

This economic forecast incorporates the private sector view that production and consumer prices, measured by GDP inflation and Consumer Price Index inflation, will evolve similarly over the forecast horizon, increasing by about 2 per cent on average over the next five years.

The economic forecast in the September 2010 survey implies that the weak and negative economic growth experienced in 2008 and 2009 in Canada is not expected to be offset over the medium term by stronger growth. This is to say that the expected average rate of economic growth between 2010 and 2015 is no higher than the rate of growth expected by private sector forecasters over the same period prior to the recession. The private sector average forecast for inflation in the September survey is also consistent with unchanged commodity prices over the next five years.

In response to the projected moderation in growth in the second half of 2010 and the first half of 2011, forecasters have lowered their interest rate projections over the entire forecast horizon. Three-month treasury bill rates are now expected to be lower by an average of about 50 basis points between 2010 and 2014 compared to the forecast presented in Budget 2010, while 10-year government bond rates are expected to be lower by an average of about 75 basis points.

Reflecting Canada’s strong labour market performance since Budget 2010, private sector economists are now forecasting an unemployment rate of 8.0 per cent for 2010, down from 8.5 per cent at the time of the budget. The unemployment rate for 2011 has also been revised down to 7.7 per cent. The unemployment rate is expected to continue to gradually decline over the remainder of the forecast horizon.

The uncertainty surrounding the economic outlook remains elevated. In the short term, private sector expectations for the third quarter of 2010 vary widely around the average forecast of 1.8 per cent, from a minimum of 0.7 per cent to a high of 3.0 per cent. Moreover, the uncertainty with respect to the medium-term outlook, as measured by the difference between the average of the three highest and three lowest forecasts for the level of nominal GDP, remains somewhat high by historical standards, but has diminished significantly over the past year. This difference in 2014 is $57 billion, roughly unchanged since Budget 2010, but down from the record $98-billion difference for the five-year ahead forecast at the time of the September 2009 Update of Economic and Fiscal Projections.

Table 2.1
Evolution of the Average Private Sector Economic Forecast
  2010 2011 2012 2013 2014 2015 2010–2014
  (per cent, unless otherwise indicated)
Real GDP growth              
  December 2009 survey/Budget 2010 2.6 3.2 3.0 2.8 2.6 2.9
  June 2010 survey 3.5 2.9 2.8 2.8 2.5 2.5 2.9
  September 2010 survey/Update 2010 3.0 2.5 2.8 2.9 2.6 2.5 2.8
GDP Inflation              
  December 2009 survey/Budget 2010 2.2 2.1 2.2 2.1 2.0 2.1
  June 2010 survey 3.2 2.2 2.2 2.1 2.0 2.0 2.3
  September 2010 survey/Update 2010 2.8 2.0 2.3 2.0 2.0 1.9 2.2
Nominal GDP growth              
  December 2009 survey/Budget 2010 4.9 5.4 5.3 4.9 4.7 5.0
  June 2010 survey 6.8 5.2 5.1 4.9 4.6 4.5 5.3
  September 2010 survey/Update 2010 5.9 4.6 5.2 5.0 4.6 4.4 5.0
Nominal GDP level ($ billions)              
  December 2009 survey/Budget 2010 1,601 1,688 1,778 1,865 1,953
  June 2010 survey 1,631 1,716 1,802 1,890 1,977 2,066
  September 2010 survey/Update 2010 1,618 1,692 1,780 1,868 1,954 2,039
  Difference (update - budget) 17 4 2 3 1  
3-month treasury bill rate              
  December 2009 survey/Budget 2010 0.7 2.4 3.8 4.3 4.4 3.1
  June 2010 survey 0.7 2.3 3.4 3.9 4.3 4.3 2.9
  September 2010 survey/Update 2010 0.6 1.6 2.7 3.5 4.0 4.0 2.5
10-year government bond rate              
  December 2009 survey/Budget 2010 3.7 4.3 4.9 5.2 5.3 4.7
  June 2010 survey 3.6 4.1 4.5 4.9 5.1 5.2 4.4
  September 2010 survey/Update 2010 3.2 3.3 4.0 4.6 4.8 4.9 4.0
Exchange rate (U.S. cents/C$)              
  December 2009 survey/Budget 2010 95.5 98.3 97.7 99.3 98.5 97.9
  June 2010 survey 97.2 98.0 97.3 96.5 96.3 95.8 97.1
  September 2010 survey/Update 2010 95.8 96.7 98.2 98.0 97.5 97.0 97.2
Unemployment rate              
  December 2009 survey/Budget 2010 8.5 7.9 7.4 6.9 6.6 7.4
  June 2010 survey 8.0 7.6 7.2 6.8 6.6 6.5 7.2
  September 2010 survey/Update 2010 8.0 7.7 7.4 7.0 6.8 6.6 7.4
Consumer Price Index inflation              
  December 2009 survey/Budget 2010 1.7 2.2 2.1 2.1 2.1 2.0
  June 2010 survey 2.0 2.3 2.2 2.1 2.0 2.0 2.1
  September 2010 survey/Update 2010 1.7 2.2 2.1 2.1 2.0 2.0 2.0
U.S. real GDP growth              
  December 2009 survey/Budget 2010 2.7 3.0 3.4 3.1 2.9 3.0
  June 2010 survey 3.2 2.9 3.2 3.2 3.0 2.8 3.1
  September 2010 survey/Update 2010 2.7 2.4 3.0 3.1 3.0 2.7 2.8
Sources: Budget 2010; Department of Finance December 2009, June 2010 and September 2010 surveys of private sector forecasters.

Risk Assessment and Planning Assumptions

On October 4, 2010, the Minister of Finance met with the private sector economists to discuss the economic outlook in the September 2010 survey as well as the risks surrounding the outlook.

The economists highlighted that the near-term global economic outlook remains highly uncertain. While the global economy continues to recover, its pace remains fragile and uneven due to a number of risks.

In most advanced economies, including the U.S., private domestic demand has been weak, with policy stimulus and the rebuilding of inventories largely supporting the recovery. This raises the risk that global economic growth over the near term could be weaker than expected if private domestic demand does not strengthen as expected. Conversely, some private sector economists noted that a stronger-than-expected recovery in private domestic demand in these countries is also possible given the extent to which these growth projections have already been revised downward.

Additionally, while the policy response to the European sovereign debt crisis has successfully reduced financial market pressures, renewed tensions are possible, having potentially negative implications for the international financial system, from which Canada would not be immune.

These global challenges, particularly the uncertainty surrounding the strength of the U.S. recovery, pose a risk to the Canadian economic and fiscal outlook, particularly over the near term. In light of the current downside risks to the global outlook, the Government has judged it appropriate to adjust downward the private sector forecast for nominal GDP for its own fiscal planning purposes.

With this adjustment, the level of nominal GDP is assumed to be $10 billion lower by 2011 and 2012 than projected in the September 2010 private sector survey (Table 2.2). This is equivalent to a reduction in economic growth of about 0.5 percentage points, at annual rates, for four quarters, starting in the third quarter of 2010. The adjustment for risk due to current economic conditions is reduced to $7.5 billion in 2013 and to $5.0 billion thereafter, as the downside risks to the long-term outlook are considered to be smaller. The Government will continue to evaluate economic developments and risks to determine whether or not it would be appropriate to maintain this downward adjustment for risk in the future.

Table 2.2
Update Planning Assumption Comparison
  2010 2011 2012 2013 2014 2015
  (billions of dollars)
Nominal GDP level            
  September 2010 private sector survey 1,618 1,692 1,780 1,868 1,954 2,039
  Update 2010 fiscal planning assumption 1,616 1,682 1,770 1,861 1,949 2,034
  Adjustment for risk -2.0 -10.0 -10.0 -7.5 -5.0 -5.0

1 All growth rates in this section are at annual rates, unless otherwise indicated.