Does Canada need a Fiscal Stimulus? - Discuss

My own view, for what it's worth, is that Canada does not need a fiscal stimulus right now, but there's a possibility it might need one soon, so the government should get everything ready to introduce one as quickly as possible, but not pull the trigger quite yet. My preferred fiscal stimulus would be a temporary GST cut, and/or an increase in government investment spending, especially construction spending. (I would give a different answer for the US, UK, or Euroland, but that's not the question.)

Here is why I believe that.

Looking at data on economic activity, like employment, unemployment, sales, manufacturing, house construction, etc., I get the impression that real economic activity is slowing, but not yet dangerously so. (GDP is not on my list of indicators, because I have become very wary of GDP figures over the last couple of years, though that's another story.) Every time Statistics Canada has released new numbers, I have been surprised on the upside, so maybe I should adjust my bearish bias (Bayesians can read "priors" for "bias").

Looking at data on prices, like CPI and wage inflation, I get the impression that prices are slowing, but not yet dangerously so. Commodity prices, especially oil, have been falling rapidly over the last few months, but are not yet low relative to normal levels. And the recent fall of commodity prices measured in US dollars has been partly offset by a falling exchange rate. Stephen's post showing big deflation on durable goods prices  http://worthwhile.typepad.com/worthwhile_canadian_initi/2008/11/monetary-policy-and-durable-goods-deflation.html worries me, but as he says it is probably a lagged effect of exchange rate appreciation, in which case it should reverse soon. Stock prices are down, but not cliff-diving.

Anecdotal evidence, which includes anything ranging from newspaper stories, talking to normal people (i.e. non-economists), to trivia like the fact that Canadian Tire just doubled my credit card limit, do not contradict the above stories. Spending 12 hours a day sitting at home reading everything I can about the crisis (hey, I'm on sabbatical, and anyway it's my job to try to understand this stuff) gives me a warped sense of reality; if normal people were as concerned as I am, I would be more concerned (multiplier effects).

Offsetting all that, my biggest fears are: falling export demand from a weakening rest of the world, especially the US; our belatedly falling house prices will cause construction (which has been very strong) to fall a lot; there is some hidden (to me) time bomb in the Canadian financial system (not so much mortgages, where the most risky ones are CMHC-insured, and unlike the US ours are recourse mortgages, but something else I don't know about).

The Bank of Canada still has room to cut the overnight rate, and to pursue quantitative easing more aggressively. I think we should first use monetary policy, because it is quicker to implement, quicker to reverse, has a wider impact on the economy, is less likely to be politically distorted, will not increase the national debt, is a more radical solution (in the original sense of the word), and because that's been the rule of the game for the last 20 years.

I think further monetary policy stimulus will be enough. But a deflationary spiral would be very nasty, and I can't rule it out. If it gets bad enough, then pure monetary policy (i.e. holding government spending, taxes, and transfers constant), even including quantitative easing, won't be enough, as I argue in http://worthwhile.typepad.com/worthwhile_canadian_initi/2008/11/shooting-bears-ammunition-and-central-banks.html . And the perceived increase in risk and illiquidity of assets has reduced asset-substitutability and weakened the effectiveness of normal monetary policy across the interest rate curve. But a money-financed fiscal policy will always work, provided it is big enough. And if interest rates hit the zero lower bound, any fiscal deficit would in fact be money-financed http://worthwhile.typepad.com/worthwhile_canadian_initi/2008/11/will-deficit-spending-in-fact-be-moneyfinanced.html

A GST cut, announced as temporary, like in the UK, could be the weapon of last resort. People would increase spending while taxes are low. It could be implemented quickly if needed. It could have a big temporary bang for the fiscal buck. But we cannot be 100% certain that people would increase spending. And I'm not 100% certain how it would influence deflationary expectations. An increase in government spending would work. But it takes time to implement, which is why I want the government to start planning for it now, but to hold fire for the moment. And if construction spending falls, as I think it must, the unemployed construction workers, and unemployed bulldozers, would be ready and waiting.

(I am looking at this purely from the macro-perspective. I have no idea whether or not we need more sewers and whether some infrastructure spending could be justified independently on micro-grounds.)

Here's what some other Canadian economists think: http://ca.news.finance.yahoo.com/s/28112008/2/biz-finance-flaherty-says-stimulus-necessary-economists-warn-against.html

Discuss. What data and arguments am I forgetting? What anecdotal evidence do you have? How scared are the "normal" people you know (if you are reading this blog, you yourself are not "normal")?

Comments

[Robert McClelland]

a temporary GST cut

Don't be silly. A "temporary" GST cut would be a permanent GST cut simply because no government would have the guts to end it.

As far as the idea itself, I think it would be far easier and more effective to give Canadians a one time [insert whatever name sounds good] rebate. If the government is willing to hand me a hundred bucks I'm more than willing to do my part by going out and spending it.

[Stephen Gordon]

Nick, that last link was broken, so I fixed it. We don't see as many stories like that as we should.

[Nick Rowe]

Thanks Stephen! I still have to learn how to do links properly, and that neat "below the fold" thing. (Check your email)

Robert: I think you have a good point: a one-time, lump-sum, across the board $500 per person (say), transfer increase/tax cut (same thing) would be more likely to be automatically self-reversing politically. But a temporary GST cut would have a substitution effect (spend more now, because it's relatively cheap now), as well as an income effect (spend more, because I can afford more), so it would be more effective per dollar of deficit.

[ignorantmike]

I'm a little skeptical of GST cuts or stimulus checks. As mentioned above (and everywhere) expectations can overwhelm any potential benefit. Equally common is the argument that the money might leave the country as folks spend on imported goods.

re: Public Mood: In general, I am one nervous Canuck. Though I too have seen that people's expectations have yet to seriously dip, this could change very quickly. I've spoken to a few people who are newly concerned, principally because of Citi (lots of Citi cards out there), and BCE (lots of retail investors). Even the public servants are reticent to press the union to take action. Retirees are crapping their pants, and they are more often than not sharing their thoughts with their kids.

Beyond the middle to upper earners, the pot-smokin, beer-drinkin, junior hockey lovin crowd seem to readily accept the notion that the US "is gettin its due." While the (TV) news largely ignores the fancy crap discussed on pages such as these, their programs do contain more than a few references to hard times: charities robbed, food banks crowding, declining donations for charities. Imagine the effect if a big Canadian retailer suddenly found itself on the brink? So, yeah, I suspect expectations are likely to get much worse as more extreme data worms its way through the news.

Besides, Canadians seem to be getting more and more cycnical/skeptical/pessimistic/angry as time goes on (here I point to preexisting trends in political values). On that note, Canadians are likely to be a very difficult bunch when it comes time to build support for ANY stimulus or recovery "plan." I think many will assume that whatever action comes from government, it will be meaningless and/or symbolic. Accordingly, they will hunker down.

But what do I know?

[JKH]

I have nothing by way of data, arguments, or anecdotal evidence to offer – except that as of a month ago, based on a detailed conversation with my personal banker, the Canadian mortgage business was booming. I have a feeling that’s beginning to fall off considerably. And I think the house price correction in Canada may be more significant than built into current expectations. At least somebody reigned in the incredibly irresponsible action of CMHC to create 40 year amortization mortgages at the peak of the boom.

I’m reminded of a phrase that Greenspan used during the Asian crisis, which transformed would be that Canada can’t remain an oasis of prosperity in a global contraction. It’s coming – it’s just delayed. The government’s approach so far is as laid back as the US’s is frenetic. We need to be prepared, but dastardly politicking seems front and center in the near term. As you point out, we have more room than the US to manoeuvre on monetary policy, which provides some breathing room pending a decision on further fiscal action.

[Alex Plante]

I'm a civil engineer in Montreal. I design road and municipal infrastructure projects for a large diversified engineering firm. Montreal is so far still in the midst of the construction boom that began in 2000. Several recent tenders our firm prepared for infrastructure projects went no bid or had very few bidders, which is something none of the most senior engineers had seen in over 30 years experience. Construction firms tell us they have too much work.

The primary need for infrastructure investment in the Montreal area is for the rehabilitation of existing aging infrastructure, and since Montreal is an Island, we need to solve the transport bottleneck problems caused by the shortage of bridges to the island (ex. the Highway 30 by-pass, more commuter trains, etc.).

You should not forget than an important stimulus for the Canadian economy is the US/Can dollar exchange rate. If oil prices stays below 65US$/bbl, if Ontario's auto industry collapses, if the housing markets in Vancouver, Edmonton, Calgary and Toronto start to deflate, then the Canadian dollar will drop, which will help non-auto and non-pretroleum exports.

I believe that Montreal's housing and economic boom since 2000 was really a recovery from the 25-year depression we suffered from 1974 to 1999, and was facilitated by the low interest rates and cheap dollar that followed the 1997 Asian economic crisis. That the boom has endured in spite of the sharp appreciation of the dollar after 2003 and that we have so far not been much affected by the global financial crisis is proof that Montreal's recovery was real and not a bubble.

I think any infrastructure spending stimulus should be limited to financial aid to projects that are already planned, but are threatened with cancellation because of financial troubles.

[DYoung]

It seems me that such planning needs to be announced, and set in stone in order for it to work in time. Infrastructure funding that is shared with other levels of government would have the largest impact yet this program needs to be defined to the point that other governments or partners can develop projects. It seems to me that for things to be in place for this year you have to decide now.

As for anecdotal evidence, in our little corner of New Brunswick we are still seeing significant growth with $10 billion worth of investment slated for the next decade. This sort of planned investment has driven up home prices and driven down unemployment.
The downside? One of the backers of those investments said they are going to go a little slower than originally planned given the recent economic turmoil.

[Stephen Gordon]

Alex Plante: Thanks for that insight. In the companion post, I was wondering where we were going to find workers to build that new infrastructure.

[B. MacInnis]

Not being an economist you will have to excuse my ignorance, but I do remember many years ago in Econ 101, a frequent complaint of our professor was governmental fiscal intrusions to counter economic downturns were usually too slow and too late. The result, we were told, was the stimulus affected an already growing economy and thus was inflationary, thereby causing the variability of the economy to increase. If true, does this not imply that action should be taken in advance of the "proof" of a recession, since the proof is always seen with hindsight by definition?
As far as anecdotal consumer spending, the mall where I work is no where as busy as the two previous years at this time and I am seeing many sales. In the last two years I have not seen many pre-Christmas sales (I rarely buy at full price, probably my Scottish ancestry).

[Nick Rowe]

ignorantmike: yes, the wealth effect from lower stock prices may have a considerable effect on spending (especially for those soon to retire). I had forgotten that in my post.

JKH: (same JKH who comments on WB's blog? If so, I liked your proposal on Fed transparency, and am currently debating whether to post here on banks' balance sheets from our discussion there. If not, sorry!). Yes, I think much worse is yet to come in Canada, when house prices fall further and new housing construction slows, which is why I think..

Alex's hard anecdotal evidence certainly backs up Stephen's data for now, but I don't see it lasting much longer, and like...

B MacInnis, that we need to plan now, in advance of the downturn (but not implement anything yet until we do see unemployed construction workers), though if...

DYoung is right about the plans needing to be "set in stone" (meaning you have to go ahead with them, and can't stop if they're not needed?) that might not be so easy.

My daughter #2 just returned briefly from Toronto, where she has a Christmas retail job, and tells me business is good, and there are many jobs posted in retail.

[JKH]

same, Nick ...

[ramster]

I'd add to B. MacInnis's concern about the lag time of any significant fiscal stimulus, especially in infrastructure development. These projects take time to get moving and the earlier the better. I'd turn the question around and ask what the downside is of starting up a significant fiscal stimulus package now? Something like $40 billion of committed spending over the next 4 years towards things like Toronto's transit city initiative and the 407 extension to the east (just 2 examples in my neck of the woods). Another important element would be extending the duration of EI payments and reducing the criteria for getting them (i.e. fewer weeks worked). EI gets into the pockets of people who're going to spend every penny out of need, thus helping those who are hurting the most and maximizing the stimulus effect (compared to a GST cut). So what's the downside? Obviously it means running significantly larger deficits and increasing the debt. But what was the point of the last 15 years of relative fiscal prudence if not to provide us with the firepower we need when things are looking particularly nasty? Our debt/GDP ratio is the best in the OECD so we can handle the debt growing by 50 billion (ish). If things don't end up being that bad, we still get a lot of productive infrastructure. By committing the funds towards capital projects with finite durations, we can avoid the risks of a permanent increase in government outlays. I do agree that any help to the auto sector should wait until the Obama administration takes office so that it can happen in a coordinated manner between Canada and the US.

[Phillip Huggan]

We have to be reactionary with what happens in our trading partner while pre-emptively making long-term reactions, before (?!) US import demand contracts.
S.Gordon mentioned on another post his favourite prescription would be temporary GST cut. There are many but mine would be esoteric export subsidies to APEC trade arena. More realistically a high speed rail line between Buffalo and Montreal or wherever, would be timely. Same line between Edm Cgy whenever oil sands contract.
Not that governments should trade, but it looks like traders have exited long plays on physical commodities including contruction inputs. I can't see the short position of copper ever forming a bubble but I can see hot money once again inflating long positions. It might be a good time for governments to lock in construction materials processes.
What is really asked here is what are the order of events that will proceed business-as-usual Canada unemployment? Do USA consumers stop going into debt gently or do they develop Japan-style savings rates? Obama has middle class spending initiatives and fat cat taxes but also need to balance budget and high Iraq costs. If they don't balance budget ever again this panic becomes a permanent Canadian problem.

In general, Keynes works because when something is screwing up short-term investments (derivatives and conflicts of interest) the long-term ones don't get saturated before the short-term problem is fixed. Maybe the Asian Crisis that avoided China is a model for Canada but that could just be because of closed capital flows.

[lickedcat]

We have all the fiscal stimulus we need thanks in most part to the US current and future taxpayers.
We should take the free ride for all its worth and use our resources more selectively. If we are worried about CAW pensioners losing their pensions then guarantee their pensions directly and let the Detroit 3 slip into bankruptcy. Forestry, big retraining program and adjustment programs. Just like fishermen from NFLD, get them into something else. I would like to see the government really focus our manufacturing industries into R&D on automation and robotics, its the only way to compete against China and India. Unless we want to compete on lower wages.

The best policy is to keep the government contained, politicians love to meddle, they can't stop themselves.

[lickedcat]

We have all the fiscal stimulus we need thanks in most part to the US current and future taxpayers.
We should take the free ride for all its worth and use our resources more selectively. If we are worried about CAW pensioners losing their pensions then guarantee their pensions directly and let the Detroit 3 slip into bankruptcy. Forestry, big retraining program and adjustment programs. Just like fishermen from NFLD, get them into something else. I would like to see the government really focus our manufacturing industries into R&D on automation and robotics, its the only way to compete against China and India. Unless we want to compete on lower wages.

The best policy is to keep the government contained, politicians love to meddle, they can't stop themselves.

[Andrew F]

I have to agree with the previous poster about whatever stimulus is delivered. The political reality is that the US carmakers will be bailed out in some form. I think the best solution is Chapter 11, with government providing partial guarantees for existing pensions (60%- 75% range) and allowing the Big Three the shed debt, renegotiate union deals and shut down unproductive dealerships and plants.

Beyond that, given that there is a $53 billion surplus in the EI fund, it doesn't seem terribly inappropriate to use this to improve benefits to the unemployed.

Committing funds to infrastructure projects allows the preliminary planning to be undertaken so that when labour market conditions are conducive to these projects they can more rapidly be commenced.

I'm encouraged that regardless of whether the CPC can hold onto power of the coalition of opposition parties manages to usurp them, both have committed to continuing to reduce corporate income tax rates on schedule. Shoring up accelerated capital cost allowances and other measures to encourage investment in the manufacturing industry would also be helpful whether the stimulus is needed or not.

[commonsense]

Robert McClelland:

You write "Don't be silly. A 'temporary' GST cut would be a permanent GST cut simply because no government would have the guts to end it."

This shows that you think it's better to take money from people by force and then pretend you are being generous by giving a little bit back... at your discretion and on your terms, of course.

This is precisely the mindset that causes government to do evil in the name of helping. When this mindset to prevails, free men are turned into slaves. And therefore this mindset must be rooted out at all costs.

lickedcat, on the other hand knows the way to keep what little freedom we have left. He writes "The best policy is to keep the government contained..."

Yes indeed. You are so right, lickedcat!

[commonsense]

Stephen Gordon:

I agree with you. Canada does not need any form of stimulus package at present. That may change, and if it does, we should be prepared to act swiftly and decisively. But the industries greedily reaching their hands into the public coffers at this point are just that – greedy, not needy. The US stimulus package will be more than enough to buoy them up. If we give in to their whining now, we will put the stimulus in the wrong place. And then we will have that much less to work with if things do turn sour. But I don’t think it will. I think Canada can survive this downturn without going to extraordinary lengths. And if we do, we will enter the next upswing in a truly strong position.

It seems to me that Mr. Harper is doing exactly the right thing for the time being.

And the opposition are shamelessly preparing to steal from the people of Canada.

[Toro]

Good post.

However - "Stock prices are down, but not cliff-diving." Stocks are down 50% in four months, the steepest decline since the 1930s. If this isn't cliff-diving, what is?