Canada weathered the global recession better than most other industrialized countries and is the only G-7 country to have more than recovered both all of the output and all of the jobs lost during the recession.
This strength reflects the significant policy stimulus put in place at the onset of the recession, along with Canada’s solid economic and financial fundamentals, which have sustained domestic demand in a fragile global economic environment.
However, the global economic situation and outlook have deteriorated recently, and uncertainty over the outlook has risen, largely reflecting the negative impacts of the sovereign debt and banking crisis in Europe and concerns over the sustainability of the U.S. fiscal situation. This uncertainty has shaken consumer and business confidence and resulted in sharp declines in equity values worldwide. As a result of this deterioration in the global economic situation and outlook, private sector economists have reduced their outlook for Canadian economic growth since Budget 2011, in particular for 2011 and 2012.
This chapter reviews the major global and Canadian economic developments since Budget 2011, describes the private sector economic forecast that forms the basis for the fiscal projections, and discusses the risks and uncertainties surrounding this economic forecast.
Following stronger-than-expected growth in late 2009 and early 2010, the pace of the global recovery slowed in the first half of 2011, and is expected to remain modest going forward. Growth decelerated, particularly in advanced economies, reflecting the waning effects of extraordinary fiscal stimulus measures and transitory factors such as the earthquake and tsunami in Japan, but also a lack of confidence in the efforts of some governments to put public finances on a sustainable path. As a result, growth in all G-7 economies slowed to around 1 per cent or lower in the second quarter of 2011.
Part of the slowdown in advanced economies was expected, reflecting the planned unwinding of extraordinary government stimulus measures put in place during the recession. These temporary measures were, for the most part, introduced during 2009 and 2010 and resulted in a sharp increase in government spending that supported growth at a time when private sector demand was weak. However, these measures are now being unwound, and, unlike in Canada, private demand in many countries has yet to fully take up the slack. Consumers in many countries remain constrained by high personal debt loads and weak confidence, while the private sector is hesitant to invest and hire. As a result, most advanced economies have yet to recover all the losses in private demand suffered during the recession (Chart 2.1).
Weak underlying growth in advanced economies was exacerbated in the second quarter of this year by several transitory factors, including disruptions resulting from the earthquake and tsunami disasters in Japan and political unrest in the Middle East and North Africa region and the related surge in oil prices. In addition, second-quarter growth in the U.S. was affected by
A key factor restraining global growth more recently has been the negative impacts on confidence and equity values of growing uncertainty over the ability of some countries to put their public finances on a sustainable path.
In the U.S., the protracted political debate over the federal debt ceiling and the subsequent downgrade of the country’s debt by Standard & Poor’s have shaken public and business confidence in the ability of the U.S. government to effectively manage its fiscal situation, notwithstanding the last-minute resolution of the debt ceiling impasse. This uncertainty has exacerbated the underlying difficulties in the U.S. economy, due to ongoing consumer deleveraging and continued weakness in the housing market.
In Europe, the impact of the sovereign debt and banking crisis worsened in late summer and into the fall of 2011, as markets became increasingly sceptical of the ability of governments to deal with the excessive levels of public debt in a number of Euro zone countries. As a result, borrowing costs for some of these economies rose significantly, with yields on 2-year government bonds for Greece and Portugal at or near record highs by early November (Chart 2.2).
These strains have continued, despite the October 26 announcement by European authorities of a set of policy measures aimed at containing the sovereign debt and banking crisis, including greater capital requirements for European banks, an increase in the European Financial Stability Facility to up to one trillion euros, and an agreement that private creditors of Greek sovereign debt would accept a 50 per cent discount on their claims. While global equity markets initially responded positively, financial markets remain volatile and interest rates remain elevated for certain European nations. The measures announced on October 26 are only a first step by authorities in resolving the sovereign debt and banking crisis. Meeting at a time of considerable uncertainty with respect to developments within the Euro zone, G-20 leaders at the Cannes G-20 Summit on November 3-4, 2011 welcomed the Euro zone’s plan and urged that it be rapidly elaborated and implemented.
The effects of this heightened level of uncertainty in Europe and the U.S. are reflected in economic data. In Europe, recent economic indicators, in particular indexes of manufacturing and service activity, suggest that the Euro zone may already be in recession.
In the U.S., revised national accounts data now show that economic activity over the past three years was weaker than previously reported, with the U.S. recession deeper and the recovery slower than previously estimated. Indeed, the level of U.S. real GDP at the end of the second quarter of 2011 was still below its pre-recession peak (-0.4 per cent), in contrast to Canada which has more than recovered all of the output lost during the recession. Along with other major economies, data for the first half of 2011 show that the U.S. economy entered a soft patch, with first-quarter real GDP growth at a mere 0.4 per cent and second-quarter growth at a modest 1.3 per cent.
Reflecting this modest output growth, the recovery in the U.S. labour market has also stalled. After gains of around 200,000 in three of the first four months of 2011, the pace of job creation in the U.S. has slowed sharply, to an average of just 90,000 per month through October. Private sector hiring has fared somewhat better, averaging almost 120,000 per month over the same period. As a result, U.S. payroll employment remains 4.7 per cent below its peak, while the unemployment rate is at 9.0 per cent, more than double its pre-recession trough of 4.4 per cent.
Nonetheless, private demand in the U.S. appears to be holding up, albeit at modest levels. While uncertainty surrounding the economic outlook and the U.S. fiscal situation, as well as declining equity prices, have left consumer confidence near cyclical and historical lows, other recent indicators of economic activity suggest continued growth. In particular, strong retail sales point to ongoing consumer spending growth while solid increases in production of machinery and equipment (M&E) suggest further strength in business investment (Chart 2.3).
Overall, momentum in the U.S. economy heading into the second half of the year remains moderate, with third-quarter growth accelerating from the first-half slowdown to 2.5 per cent. Third-quarter growth was boosted by a rebound in consumer spending growth to 2.4 per cent, while business investment growth accelerated to over 16 per cent. However, the ongoing drag from U.S. housing market weakness and continued high household debt, together with uncertainty over the U.S. fiscal situation, continues to weigh on consumer and business confidence, which may cause a “wait and see” approach to spending on the part of households and businesses.
As a result, private sector economists have revised down their outlooks for U.S. real GDP growth significantly since Budget 2011. Private sector economists expect growth of 1.6 per cent for 2011 and 2.0 per cent in 2012, down from 3.1 per cent growth expected in both years in the budget (Chart 2.4).
In emerging and developing economies, the pace of economic activity has also slowed somewhat but remains strong. In China, the trade sector has held up reasonably well despite slower growth in advanced economies, which has helped support economic activity. Overall, economic growth in China remains robust, with real GDP rising 9.5 per cent in the third quarter of 2011 after increasing by 10.0 per cent in the second quarter.
Reflecting slower-than-anticipated global growth during the first half of this year, the IMF has downgraded its outlook for the global economy. The IMF expects global economic growth of 4.0 per cent in both 2011 and 2012, down from expectations of 4.4 per cent and 4.5 per cent, respectively, in the April 2011 World Economic Outlook. This downward revision comes largely through lower growth expectations for advanced economies, which the IMF expects to expand by just 1.6 per cent in 2011 and 1.9 per cent in 2012, nearly a percentage point slower in both years than anticipated in April. The IMF expects emerging economies to be less affected, with growth expected to remain relatively strong, in spite of the dampening impacts on growth of capacity constraints, policy tightening and slowing foreign demand.
Economic weakness, along with the negative impacts of uncertainty over fiscal sustainability in some countries, has been most keenly felt in financial markets. European financial institutions have also come under pressure, reflecting their exposure to the sovereign debt of a number of European countries, in particular Greece, Ireland and Portugal, which has resulted in sharp declines in equity values and indications of re-emerging interbank lending pressures.
Further, the debt ceiling impasse in the U.S. last July resulted in sharp declines in equity values globally and a generalized flight to less risky assets. Even when the debt ceiling was ultimately raised on August 1, markets continued to fall sharply in anticipation of the possibility of a credit downgrade of U.S. sovereign debt, which was realized on August 5 when one of the three major credit rating agencies, Standard and Poor’s, lowered its U.S. debt rating from AAA to AA+.
As a result of the turbulence in Europe and the U.S. and fears of weaker global growth ahead, major stock markets lost between 15 and 25 per cent of their value between late July and early October, before improving somewhat in the following weeks. Markets continued to rise briefly in the wake of the October 26 announcement from Euro zone authorities of measures to begin to address fiscal and banking concerns in the region, but have since retreated and continue to exhibit a high degree of volatility (Chart 2.5).
As with equity prices, weaker economic growth prospects, combined with growing investor uncertainty and a general flight from risk, have resulted in sharply lower commodity prices. West Texas Intermediate (WTI) crude oil prices, which had been boosted by political events in the Middle East and North Africa region to over US$110 per barrel earlier this year, declined sharply along with equity prices. As a result, oil prices remain down more than 5 per cent since the 2011 budget, despite some recent improvement, with most other commodity classes also posting declines (Chart 2.6). Conversely, a flight to quality and perceived safe-haven assets boosted precious metal prices, with gold rising to a record high in early September, before retreating somewhat over recent weeks. Average futures contracts over the two weeks ending November 4 suggest that financial markets expect WTI crude oil prices to average US$94 per barrel in 2011 and US$92 in 2012 and Henry Hub benchmark natural gas prices to average US$4.10 per MMBtu in both 2011 and 2012.
Canada weathered the global recession better than most other industrialized countries and is the only G-7 economy to have more than recovered both all of the output and all of the jobs lost during the recession. The most recent IMF outlook suggests that Canada, along with Germany, will continue to enjoy the strongest growth on average in the G-7 over the 2011–12 period.
Canada’s strong GDP growth has been reflected in a robust labour market performance to date, with almost 600,000 more Canadians working today than in July 2009—the strongest employment growth in the G-7. Canada’s labour market recovery has been strong and widespread, with all regions posting job gains over the recovery. Furthermore, close to 9 in 10 jobs created since July 2009 have been full-time positions and in high-wage industries, with three‑quarters in the private sector (Chart 2.7).
The recovery in employment in Canada contrasts sharply with developments in the U.S., where employment remains significantly below pre-recession levels (Chart 2.8). As a result, the Canadian unemployment rate has fallen to 1.7 percentage points below that of the United States and has been below the U.S. unemployment rate since October 2008. This phenomenon has not been seen in three decades. When Canadian unemployment is measured on the same basis as in the U.S., the unemployment rate gap between the two countries increases to 2.5 percentage points.
However, employment dropped in October, largely offsetting the strong gain posted one month earlier. Consequently, employment in Canada is almost unchanged since July 2011. The pause in job growth since the middle of the year is consistent with the deterioration of the global economic situation. To provide support to Canadian workers, in this Update the Government is reducing the maximum potential increase in EI premiums for 2012 from 10 cents to 5 cents per $100 of insurable earnings, and is providing an additional extension of up to 16 weeks for active, recently terminated or new work-sharing agreements until October 2012. The Government is prepared to respond in a flexible and measured manner to support jobs and growth, if the economic situation deteriorates further.
Real economic output in Canada expanded for seven consecutive quarters, from the end of the recession in the third quarter of 2009 to the first quarter of 2011 (Chart 2.9). However, growth paused in the second quarter, as weaker growth in the major advanced economies, particularly the United States, and the high value of the Canadian dollar contributed to a sharp decline in exports. Moreover, Canadian exports were further dampened in the second quarter by temporary factors, including supply disruptions related to the Japanese earthquake and tsunami disasters, and interruptions in energy exports due to unexpected maintenance shutdowns and the major forest fire in the Slave Lake region. Indeed, monthly real GDP rose 0.4 per cent in July and 0.3 per cent in August, suggesting that real GDP growth strengthened in the third quarter to the 2-per-cent range, indicating that these temporary factors that restrained growth in the second quarter have unwound as expected.
In spite of global economic headwinds, Canada’s domestic economy has been resilient. Real domestic demand increased 3.0 per cent in the second quarter, led by a strong increase in private sector consumption and investment (Chart 2.10).
As a result, both real domestic demand and real GDP are significantly above pre-recession levels in Canada—the best performance in the G-7 (Chart 2.11).
The strength of the Canadian recovery has been fuelled by significant policy stimulus from Canada’s Economic Action Plan, solid economic and financial fundamentals and a sound fiscal and monetary policy framework, which have led to a strong rebound in consumer and business expenditures.
Canada’s economic performance over the 2008–2009 global economic and financial crisis underscores the value of its flexible inflation-targeting framework, together with prudent fiscal policy and a sound financial system. This framework has contributed to a stable and certain economic environment, supporting consumer and business confidence. Moreover, throughout the crisis, this framework allowed the Bank of Canada to support growth and the creation of jobs by lowering interest rates and introducing a conditional commitment to hold rates at a low level for an extended period, while maintaining well-anchored inflation expectations.
In view of the demonstrated benefits of the implementation of the flexible inflation-targeting framework, the Government of Canada and the Bank of Canada have agreed to renew the framework for the coming five years, with the inflation target continuing to be the 2 per cent mid-point of the 1 to 3 per cent inflation-control range. This commitment will ensure that Canadians will continue to benefit from low, stable and predictable inflation.
The Department of Finance regularly surveys private sector economists 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 2011, and includes the views of 15 private sector economists.
The September 2011 survey of private sector economists 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).
Weaker global growth, and particularly expectations of slower growth in the U.S., has led private sector economists to revise down their outlooks for real GDP growth in Canada since Budget 2011. The economists now expect growth of 2.2 per cent in 2011 and 2.1 per cent in 2012, down from expectations of 2.9 and 2.8 per cent, respectively, at the time of the budget (Table 2.1). This downward revision reflects significantly weaker-than-expected growth in the second quarter of 2011, as well as more moderate growth expected for the last half of 2011 and into the first half of 2012 (Chart 2.12). The economists expect modest growth in the 2.5-per-cent range over the medium term. As a result, the projected level of nominal GDP is now significantly lower by 2015 than the planning assumption presented in Budget 2011.
In line with expectations of slower real GDP growth, the economists have significantly lowered their interest rate projections over the entire forecast horizon. Both 3-month treasury bill rates and 10-year government bond rates are now expected to be lower by an average of about 100 basis points between 2011 and 2015, compared to the forecast presented in Budget 2011. Private sector economists expect the Canadian dollar to remain near parity with the U.S. dollar over the medium term.
The economists expect unemployment rates to remain similar to the forecast made at the time of the budget, in spite of slower growth expectations. They continue to forecast an unemployment rate of 7.5 per cent for 2011 and 7.2 per cent for 2012. They expect the unemployment rate to continue to gradually decline over the remainder of the forecast horizon and to reach 6.4 per cent by 2016.
|(per cent, unless otherwise indicated)|
|Real GDP growth|
|March 2011 survey/Budget 2011||2.9||2.8||2.7||2.5||2.5||–||2.7|
|September 2011 survey||2.2||2.1||2.5||2.5||2.5||2.3||2.4|
|March 2011 survey/Budget 2011||2.8||2.1||2.1||2.0||2.0||–||2.2|
|September 2011 survey||3.0||2.0||2.0||2.0||2.0||2.0||2.2|
|Nominal GDP growth|
|March 2011 survey/Budget 2011||5.8||5.0||4.9||4.5||4.5||–||4.9|
|September 2011 survey||5.3||4.1||4.5||4.5||4.5||4.3||4.6|
|Nominal GDP level (billions of dollars)|
|March 2011 survey||1,719||1,804||1,893||1,979||2,068||–||–|
|Budget 2011 fiscal planning assumption||1,709||1,794||1,883||1,969||2,058||–||–|
|September 2011 survey||1,711||1,781||1,861||1,945||2,032||2,120||–|
|September - March 2011 survey||-8||-24||-32||-34||-36||–||–|
|September - Budget 2011 fiscal planning assumption||2||-14||-22||-24||-26||–||–|
|3-month treasury bill rate|
|March 2011 survey/Budget 2011||1.3||2.5||3.4||3.9||4.1||–||3.1|
|September 2011 survey||0.9||1.2||2.0||2.9||3.5||3.7||2.1|
|10-year government bond rate|
|March 2011 survey/Budget 2011||3.5||4.0||4.6||4.8||5.0||–||4.4|
|September 2011 survey||2.8||2.7||3.2||3.9||4.5||4.5||3.4|
|Exchange rate (US cents/C$)|
|March 2011 survey/Budget 2011||99.7||98.8||98.1||97.4||96.5||–||98.1|
|September 2011 survey||101.2||102.1||102.1||98.8||97.9||98.0||100.4|
|March 2011 survey/Budget 2011||7.5||7.2||7.0||6.7||6.5||–||7.0|
|September 2011 survey||7.5||7.2||7.0||6.8||6.6||6.4||7.0|
|Consumer Price Index inflation|
|March 2011 survey/Budget 2011||2.4||2.1||2.0||2.0||2.0||–||2.1|
|September 2011 survey||2.9||2.0||2.0||2.0||2.0||2.0||2.2|
|U.S. real GDP growth|
|March 2011 survey/Budget 2011||3.1||3.1||3.2||3.3||3.2||–||3.2|
|September 2011 survey||1.6||2.0||2.4||2.9||2.9||2.8||2.4|
|Sources: Budget 2011; Department of Finance March 2011 and September 2011 surveys of private sector economists.|
On October 25, 2011, the Minister of Finance met with private sector economists to discuss the economic outlook in the September 2011 survey, as well as the risks surrounding the outlook. At that time, the economists agreed that the average forecast from the September survey was a reasonable basis for fiscal planning.
The economists highlighted both upside and downside risks to the outlook, largely external to the Canadian economy.
The key negative risk to the outlook identified by the economists was the possibility that there would be no firm policy response to the European sovereign debt situation, which could lead to contagion to core European countries and ultimately to global credit markets. The economists continued to assess the probability of broader contagion as relatively low, however. They also pointed to the possibility of a further slowdown in the U.S. economy, which would have clear negative implications for the Canadian economy. Over the medium term, the economists highlighted U.S. fiscal sustainability as the key downside risk.
On the domestic front, the economists raised the possibility of additional drag on the economy in the event that an external shock translated into higher unemployment rates in Canada, which could trigger deleveraging on the part of those households holding elevated levels of debt.
On the upside, they continued to see some possibility for stronger-than-anticipated global growth, particularly if European authorities were able to introduce an effective set of measures to contain the sovereign debt crisis in peripheral Europe. Indeed, since this meeting, European leaders have announced measures designed to contain and manage the crisis. However, the situation in Europe remains precarious, and the underlying problem of excessive levels of public debt remains.
The economists also identified some upside risk from the U.S., if authorities are able to steer an appropriate course between near-term support for the economy, while ensuring longer-term sustainability by introducing a credible plan to reduce budgetary deficits. This would eliminate a significant part of the uncertainty that is currently weighing on the global economy, which, in turn, would reduce volatility in financial markets and allow confidence to rise.
World prices for the major commodities produced in Canada are significant determinants of GDP inflation, and hence of nominal GDP. The level of commodity prices consistent with the average private sector forecast for GDP inflation is higher than current commodity price levels. This poses some downside risk to the level of nominal GDP projected by private sector economists, particularly in the near term (Table 2.2).
|Prices consistent with the September 2011 survey|
|Commodity price index (1997 = 100)||177||191||190||189||189||189||189|
|Crude oil (WTI, US$/barrel)||93||99||99||99||98||98||98|
|Natural gas (Henry Hub, US$/MMBtu)||3.5||4.3||4.2||4.2||4.2||4.2||4.2|
|Recent futures prices1|
|Crude oil (WTI, US$/barrel)||94||92||90||89||89||90|
|Natural gas (Henry Hub, US$/MMBtu)||4.1||4.1||4.6||5.0||5.2||5.5|
|1 Average of two weeks ending November 4, 2011.|
In light of these risks, for fiscal planning purposes, the Government has increased the downward adjustment for risk to the private sector forecast for nominal GDP relative to the 2011 budget for 2011, 2012 and 2013. The adjustment for risk now stands at $20 billion in 2011, $30 billion in 2012, $20 billion in 2013, and $10 billion annually thereafter (Table 2.3). The fiscal outlook is presented in Chapter 3.
|(billions of dollars)|
|September 2011 private sector survey||1,711||1,781||1,861||1,945||2,032||2,120|
|Update 2011 fiscal planning assumption||1,691||1,751||1,841||1,935||2,022||2,110|
|Adjustment for risk||-20||-30||-20||-10||-10||-10|
The Government will continue to evaluate economic developments and risks to determine whether or not it would be appropriate to maintain this adjustment for risk in the future.
1 All growth rates in this chapter are at annual rates, unless otherwise indicated.
2 Conceptual differences boost the Canadian unemployment rate relative to the U.S. rate. In particular, Statistics Canada considers as unemployed those passively looking for work (e.g. reading want ads) as well as those who will begin work in the near future, while the U.S. Bureau of Labor Statistics does not include either group in its unemployment calculations. In addition, the Canadian methodology includes 15-year-olds (who have a higher-than-average unemployment rate), while the U.S. does not.