The U.S. recession has some bite to it, and Ben Bernanke has dumped standard policy in favor of various alternative liquidity measures, including quantitative easing. Canada’s economy is also showing increasinf downside risks to growth:
- The labor market report showed a 71,000 decline in November employment. That may not sound like much, but it translates into roughly 560,000 jobs lost on the U.S. nonfarm payroll.
- The housing report showed new home construction tumbling 19% in November to 172,000 units.
The chart illustrates standard monetary policy by the Bank of Canada and the Federal Reserve Bank. The monetary policy measures are correlated, as the two economies are linked, and the Bank of Canada is easing alongside the Federal Reserve. However, Canada’s current credit and housing fundamentals are stronger than in the U.S., giving its interest rate cuts a fighting chance.
Comparing the two policy measures in levels – just a 0.5% differential - is misleading. The Bank of Canada’s expansionary policy has a much better chance of raising domestic demand via increased consumption and investment, although this will occur at a lag.
Canadian homeowners are not as indebted as are U.S. homeowners. Canadian mortgage debt has declined to about 30% of home values, while U.S. mortgage debt has risen to roughly 55% of home values. (Charts below can be found in the PowerPoint file here)
Canadian home prices are set to fall slightly with a weakening housing market, but home values are unlikely to tumble as did occur in the U.S.
Since the Canadian housing fundamentals are stronger, standard monetary policy – cutting the overnight rate to reduce long term interest rates (like mortgage rates) - is likely to have some lagged, but nevertheless expansionary, effects on the economy. Unlike its neighbor to the south, the Bank of Canada faces no liquidity trap at this time.
Under the pressures of a contagious U.S. credit crisis, the Bank of Canada and the Department of Finance have set up alternative policy measures to aid domestic credit markets. The Department of Finance set in place a $25 billion program to shore up the MBS market (hat tip, reader Stephen Saines). And furthermore, the Bank of Canada has initiated alternative liquidity measures - Term PRA Facility for Private Sector Money Market Instruments and Term Loan Facility.
The U.S. credit crisis has gone global, and Canada is not immune to its effects. However, since Canada’s has the world’s soundest banking system and homeowners are comparatively less indebted, the Bank of Canada’s standard expansionary policy has a good chance of stimulating consumption, investment and eventually growth.