Wednesday, December 10, 2008

Expansionary monetary policy in Canada and in the U.S.: similar, but not the same

Canada – a quintessential small-open economy – is directly linked to the U.S. economy. For a while, it looked like Canada would fare well on its own: record commodity prices rendered the Canadian economy somewhat immune to the U.S. slowdown during the first half of 2008. Unfortunately, those days are gone as oil falls to $43/barrel, and Canada is set to suffer along with the U.S. But Canada has one thing that the U.S. doesn’t have: effective standard expansionary monetary policy.

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 Bank of Canada accommodated the rising growth risks by cutting its target overnight rate 0.75% to 1.5%, which is now just 0.5% above the current Federal Reserve’s target, 1.0%.

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.

Rebecca Wilder


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  2. Hey Rebecca,

    In your opinion, how does Canada's proposed solutions to correct monetary policy, as well as troubled credit and housing markets, match up against what the US plans to, or already has implemented? From this post I understand that Canada's problems, although they mirror the US's, aren't as bad.

    Knowing that Canada is the US's number one trade partner, how has Canada managed to stay in such better shape than other major global economies that rely upon and trade heavily (both imports and exports) with the US (China #2, Japan #4)?

    Very interesting and enlightening post,


  3. RW: An exceptionally potent blog pregnant with the possibilities for comparison.

    As your latest blog after this one illustrates, there's very little to 'grab onto' to get a sense of direction at this time. I still can't decide whether massive fiscal intervention is warranted or not! There just isn't any concrete comparator to base a judgement on. Today's situation bears some resemblance to ones in the past, but Globalization alone renders this one unique. Capital is so incredibly fluid that a restrictive or conducive regime in one locale almost guarantees movement to/from another if intervention is not co-ordinated.

    Tim writes: (and asks some very good questions)
    [From this post I understand that Canada's problems, although they mirror the US's, aren't as bad. ]

    I must encourage you to read RW's blog again, Tim. You missed some truly essential points. There are some *very different* factors in the equation, as much as *in general* the US and Canada are a bound economy.

    Fiscal and Monetary policy are unique to each, and by an unintended experiment, some answers will be rendered by those differences.

    First off, Canada is one of the most, if not the most, export dependent advanced nations in the world. Oddly, Canada was able to more than tread water the last two years by domestic demand. This is due to a number of factors, but RW has indicated the most powerful, albeit indirectly due to the mortgage load: discretionary income. Candadians have had more disposable income than Americans! Many Americans find that difficult to believe, but the US has seen pitiful wage increase in the last seven years or so (the politics of that is another discussion, but I daren't go there right now, it is somewhat obvious as to whom the present Admin has been beholden to...and I'm far from being a Socialist!)

    And the big one, the really big one: The US accumulative debts: However you wish to define them Balance of Payments, Gov't Debt, Personal Debt, etc...the US is arguably the most indebted nation per-capita and in toto in the World. (the UK may in fact surpass this per-capita, it is a matter of bookkeeping as to how one tallies these things)(Brown is a master of attempted illusion)

    Now it appears that Canada's present lame-duck Gov't (this may be temporary, we'll see) has accidentally (unless they are *really* clever, and I really don't think so) left a vacuum by proroguing Parliament such that fiscal policy is left hanging. Now they do have Order in Council to proceed with some stimulus, but they do not have a free hand to act carte blanche. As in most governmental systems, it is the *money legislation* that a Gov't lives or dies on.

    The BoC just yesterday slashed rates to the lowest in over fifty years, still above the UK and the US, but expansionary by our standards.

    Will it 'do the trick"? Good question.

    People like RW are 'on the inside' and are as flustered as we on the outside. I'm in Science, but to attempt to apply logic to this situation is like trying to get white glue to stick to Teflon.

    This is a very long and involved topic, and best I wait for RW to answer Tim before going any further, but to offer a short answer to Tim, it is in RW's follow-up blog:
    [4. Sheila Bair: “We need to return to the culture of thrift that my mother and her generation learned the hard way through years of hardship and deprivation. Those are lessons learned that the current crisis is teaching us again.”]

    That is what Canada has practised for the last decade, no thanks to the present Neo-Con blow hole Flaherty. He almost blew it! (Applying US style 'Liberal' policies to mortgages, completely contrary to one of the most astute US experts on the matter, even as she was financed by GE Capital to make her presentation)

    Something that I know RW will be mentioning further (it is inevitable, as it is one of the few promising avenues to explore) is further MBS auctions...and the *method* of acution.

    The WashPost has an excellent story up today on the FHA's increasing role in events (history repeats itself in some aspects), and how the FHA is completely understaffed to deal with the fraud that is increasing.

    As with all of our governments, there are moments of brilliance and shining hope, only to be blown away by the incompetence of implemantation.

    The US is onto finding some very good solutions to a very nebulous problem. I only hope that FHA gets the help she deserves to help rescue the day.

    The US has had the answer in the past. What is occurring now is mostly a charade of the deaf leading the even deafer.

    I apologize for saying that, my vindication will come if Canada does somehow scrape through without massive fiscal injection.

    Watch those *differences* as described well by RW above to show some clues.

    Similar Tim, yes. Very similar. But mirror? No, not even close, save for certain aspects.

    And those differences can actually be seen in the US herself compared to today if you examine aspects over time.

  4. Hi Tim,

    The Department of Finance’s $25 billion MBS asset purchase program is roughly equivalent to a $220 billion-size U.S. program. This is less than half of what the Fed aims at spending ($500 billion), but the credit markets are not even close to as badly hammered as are the U.S. credit markets, so it is more likely to succeed than would a U.S. program of the same size.

    As Stephen points out, Canada and the U.S. are very different – both in consumer and firm behavior. Canada’s lending standards have not tightened like they have in the U.S.; Canada’s consumers are not indebted like they are here in the U.S.; Canada’s government runs a surplus. Over 75% or so of Canada’s goods exports are shipped to the U.S., so if U.S. import demand falls hard, then Canada is bound to go down.

    The Germans save a lot (about 10%, I think) and they are in it just as bad as is the U.S. But they have crappy Trichet running the ECB and Canada has Carney. Alongside some good policy moves and new initiatives, Canada had an appreciating Canadian dollar weighing down core inflation, so as to give Carney a little leeway early in 2008.

    Thanks for reading, and as always – good to hear from you!


    And Stephen, thank you as always for your comments.


    p.s. I don't know who this corporate bully person is, but if spamming comments like this are NOT WELCOME on this blog.

  5. Rebecca:
    As always, it's good to know my efforts at reference and research, let alone soul searching to be broad in thinking, are appreciated here.

    I must emphasis to Tim that his questions were excellent, and I followed his name to his blog, and read there for quite some time.

    RW writes:
    [qt]Canada’s lending standards have not tightened like they have in the U.S[/qt]
    If I may be so bold, allow me to state that in another way, as it may be misleading:
    Canada's lending standards have been very tight for quite some time, and remain so. The 'Credit Crunch', however, has barely affected mortgage lending until now. The storm is moving in, albeit nowhere near to the extent it has in the US or the UK, where credit is almost frozen. The factor that is being displayed in the last few days here (and the Big Five Banks relented after a few days last time) is that the full reduction in the Central Bank's 75 point cut is not being passed on.

    I must admit some sympathy for the Big Five. I'm a Centrist, and it is too easy to knock the banks whenever the consumer does not get max benefit. Wholesale rates are not fully determined by Central Banks. This is clearly evident in the UK at this time.

    Of all our economies, the UK is by far in the worst shape, but that is fodder for another day.

    The bog-simple explanation for the above (and it is grossly oversimplified): Canada has had (with Australia) the best regulated banks in the Anglo world, and in much of the advanced world. Sweden also does well. (WEF ratings, but also accepted as being the case for years).

    An even simpler description: The Canadian squirrel has stored nuts for the Winter. The US hasn't, and is also losing the nest.

    The real shame is the needless folly of it all....

    To further your point, Rebecca, on the German sentiment v Trichet et al:

    [Berlin hits out at 'crass' UK strategy
    By George Parker in London and Bertrand Benoit in Berlin
    Wednesday Dec 10 2008 16:45

    Germany's finance minister has launched a stinging attack on the "crass Keynesianism" pursued by Gordon Brown, the British prime minister, fuelling tensions on the eve of European economic crisis talks in Brussels.

    Peer Steinbr├╝ck accuses Mr Brown in a magazine interview of "tossing around billions" and saddling a whole generation with a bill for paying off British debt.

    His comments come as the European Union's 27 leaders meet in Brussels to debate a proposed €200bn fiscal stimulus package, designed to stop a protracted economic slump.]

    Whether you agree with proactive intervention or not, the UK's results have been abysmal. Merkel's Gov't's view, if wrong, can only be half-wrong. I'm truly torn on the whole 'intervention' strategy...which leads me to this, and this has been as legitimate a take on events as any promulgated yet:
    (pardon the length, it is fine food for thought)

    [...] If recessions are caused by collapsing demand, increase demand. Do not wait on tax cuts or lower interest rates. They all take time. Do not plead with people to spend, as the Japanese did while suppressing interest rates to zero, or as Iceland is doing with its patriotic slogan: "Spend for your country."

    Get people to spend by giving them money, and just stop them saving it. Give them non-cashable vouchers for domestic goods and services that expire in three months. Drive them to the high streets, supermarkets, restaurants, entertainments, garages, anything that is not saving and has an employment multiplier effect. Only firms should be able to bank the vouchers. Demand must feed straight into business revenue, because revenue is collateral for credit. Without revenue, boosting credit is pointless.

    There is no shortage of the requisite money in the Treasury. We know because anyone can get it if a banker. The government is obsessed with bankers. The whole thrust of policy is aimed at trying to get banks to offer credit. But this was last August's problem, and it conspicuously failed to stem recession.

    Credit is still the obsession of public policy. The government is underpinning bank deposits and shares to the tune of a staggering £500bn in guarantees and £50bn in real money. The giveaway to banks must have reached its limit. Cuts to bank rate have little effect on the real economy.
    Some £1,000 for every man, woman and child in the land has gone into saving banks, the most extravagant policy of all time. Yet all this is aimed at forcing banks to do precisely what caused the credit collapse in the first place. It is aimed at making them lend to people and businesses which, with each passing week, are ever less able to pay them back. As the Guardian's economics editor wrote despairingly on Monday, "nothing seems to be working".

    Having failed to halt the run on credit in September, the authorities are now trying to halt it when the disease has gone elsewhere, into the cash economy. Two points off the bank rate or an inter-bank guarantee are no good to a sacked shop worker. Give that £50bn, or even half of it, to every person in the land, and it does not matter what people do with the vouchers, provided they generate economic activity. They may be traded at a discount, but that does not matter since they can only be banked by firms by the end of the period. Vouchers are better than hurling money at banks.

    The subsidies donated to stave off recession so far appear to have gone on restoring bank balance sheets, rewarding staff and lending overseas. Money being poured into projects such as Crossrail and the Olympics is going on fees to the rich, which also tend to be saved rather than spent. America is no wiser, in bailing out its least efficient car firms. It would make more sense to give people vouchers to buy cars of their choice, rather than have government choose which they may buy instead.

    Just giving people money clearly sticks in the gullet of those who run the economy. The whole point in collecting taxes is to control their disbursement. The idea of Gordon Brown going into the street and giving the public their own cash seems undignified and somehow wrong. Yet Brown, Darling, Cameron and the rest seem comfortable giving vast sums to bankers - with no condition that the money be channelled into spending. The banks say thank you but understandably decline to lend to borrowers who are going bankrupt because the government (and Bank of England) has been careless of recession.
    Even the Tories, who should welcome the vouchers as an in-the-hand tax rebate, cannot stomach the idea. The whole lot will go nobly into recession arm-in-arm with their friendly banks, rather than trust people to spend their own money rescuing the economy.

    As you can read in the url: Simon Jenkins...hardly a spring chicken or a fool.

    I tripped across a Chance Gardener phrase to describe this:
    'Feed the roots and the branches will thrive'.

    And from my emotional side: "Whose money is it anyway?"

    Of note, tonight's FT:,Authorised=false.html?

    And again, a comment: Rebecca: It is beyond perplexing for some of we 'civilians' trying to make sense of 'which way is up' at this time, and I'm well-equipped in the Sciences. It really doesn't help though.

    There is solace to be had, however, when a purveyor of the 'Dismal Science' is also at wit's end to make sense of it (in terms of a definitive overview).

    It's not just the facts and stats that you present that are essential clues, it's your personal nuances that help as much as anything.

    This is a great blog!

    Steve Saines