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Nice summary Stephen, and an excellent point about the falling Canadian dollar increasing inflationary pressures and the likelihood of the BoC raising rates in June. I have to agree with you that commodity prices are a key story in the outcome of the Eurozone crisis. On a related note, I wonder how much of the pullback in commodities is related to China slowing -- with our attention fixed on Greece, China's Shanghai's market has pulled back sharply. That may portend to sharply lower demand for commodities of all types.

Also, there's another channel by which the Eurozone crisis may affect Canada -- the EU's proposed bailout mechanism included up to $250 billion from the IMF. I assume Canada will be contributing to that $250 billion. I'm not sure how much Canada's contribution would be, but I'm guessing about $5 billion. Funny thing is, I can't decide if that amount ($5 billion) will make much of an impact on Canada's recovery.

Good points. A significant slowdown in China is probably more serious than what the eurozone crisis is likely to be.

When Canada's economy continues to become more and more dependent on commodities/resource extraction/oil that garner world prices, at what stage is it in effect decoupled from the US economy? Are we there now?

I can't really get my head around it Stephen. "How would a Eurozone crisis impact Canada?" is something I've been trying to figure out since my January 2010 Canadian economic forecast: http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/01/canadian-economic-forecasts-2010-make-yours-now.html

I don't agree with Tim Duy on US interest rates. If US interest rates fall, (or stay low longer than they would otherwise have done), that is a compensation for, and consequence of, weakening US demand. In other words, the market thinks US demand will be lower, and so expects the Fed to keep interest rates lower to try to compensate for that. It's not good news.

An exogenous fall in oil prices would be good for oil importers like the US, and bad for oil exporters like Canada. But if the low oil prices come from a weakening world economy, that's good for neither country.

My worry is that we are seeing a partial replay of late 2008. There is fear/uncertainty/whatever in financial markets, creating an increased demand for liquid assets. And the US dollar, as the world reserve currency, is the most liquid of all assets. As Scott Sumner notes, the USD is rising against the Euro, but even the Euro is rising against most things.

This is bad for world demand, and thus bad for Canada. Canadian stock prices are falling to reflect this. The fall in the Loonie is going to be some partial compensation for this.

When I saw the last employment report, I thought the BoC would need to raise the overnight rate in June, despite the high Loonie. Now I've changed my mind back again (unless the next CPI report shows very high inflation, which I don't think it will). I now think the BoC should keep the overnight rate where it is.

A lower Canadian dollar makes good sense. Terms of trade are falling. Foreign capital is exiting. Safe-haven money is flowing back into the USA.

Worse case scenario for Canada: The weakness of the Euro give an excuse for China not to move on its currency, weakness in Europe means fewer exports from the US, and an increase in the U.S. trade deficit, which leads to sever pressures on trade barriers/sanctions. That would be a net negative for Canadian.

Canadian dollar reset, closer to its fair market value of 0.92 is probably good for Canada's economy. Yes inflation pressure will rise from imported good, but it may be a near wash with the fall in energy costs (17% so far). I would suggest that BoC's primary concern is contagion risks if things in Europe keep on deteriorating, and American "deflation risk" (which would infect Canada). Should housing demand be topping off in Canada (as it appears to be), then there is no incentive for the BoC to rock the boat, and raise rates.

I would hate to be Mark Carney this week -- difficult time ahead for banks -- Oil at $65 right now!

I sure hope the Bank of Canada goes forward with the planned overnight rate target hike. The crisis of 2008-2009 is over.

Rates could come up 25 or 50 basis points and the overall monetary policy stance would remain loose relative to the formal inflation target of 2%. The same applies to the USA that needs to reverse the current course sooner than later and get on with fundamental, real reforms.

It's not clear what G20 leaders are talking about when they argue the merits of a bank tax, but the IMF proposal is online so we can read it.

The April 21, 2010 IMF proposal had 3 tax components:

1. A "retroactive tax" that would be imposed on surviving financial institutions to pay for the costs of the 2007-2010? financial crisis. The idea would be to find a nondistortionary tax based on, say, what balance sheets for banks and other financial institutions looked like in 2007. There are some subtle issues about how to do this in a way that courts won't rule illegal/unconstitutional, but the IMF thinks it can be done. And it looks like the US will impose a tax of this sort. Since there is no way to avoid such a tax by running and setting up shop elsewhere, each government can decide whether it wants to impose such a tax and at what rate.

2. A tax on all financial institutions based on the size and composition of their balance sheets.

3. A tax on the profits of financial institutions and the remuneration of their employees.

The first tax is no big deal for Canadians. It's the last two that matter. Not because Canadians love their banks but because we know that a tax on financial institutions will be borne in large part by the consumers of those financial services (i.e. us).

I have very strong objections to tax 3 (I think it's bank bashing and doesn't solve any problems), but the merits of taxes 2 or 3 per se are not what I want to focus on here.

What's been lost in the debate about a bank tax on all financial institutions is the reason the IMF gives for it: The need to fund a resolution authority.

One of the problems in the last crisis is that policy makers in the US and Europe were faced with an unpleasant choice of either funding financial institutions directly or sending them into the bankruptcy court. The latter is a very unattractive option, as we saw with Lehman. It usually takes years to sort out a bankruptcy and in the interim funds are tied up as various creditor fight over their claims, and all sorts of chaos ensues. A solution is to create a resolution authority that could step in and keep the lights running while the insolvent financial institution was either wound down or sold off; the sort of thing that the FDIC has done a few hundred times for small banks in the last two years. This requires legislation to give the government the right to do this for all sorts of financial institutions, in addition to banks. In addition, because of the size of the "too-large-to-fail" financial institutions, the resolution authority would need to have very deep pockets. The IMF argues that a "bank tax" on financial institutions (and their users) would make sense to fund the resolution authority or compensate governments for the need to pony up when the next crisis hits. (Incidentally, I don't know why the Canadian government is arguing that having a resolution authority in place that was well funded, prepared to fire top management and realize losses immediately so that shareholders would know that they would get nothing would add to moral hazard rather than reduce it).

It's good to worry about prevention, and there's a lot in the Canadian governments ECC proposal that I like. But you also have to prepare for the day when prevention isn't enough. Canadians were lucky in many ways to have avoided many of the problems that other countries faced in this current crisis. Let's admit that things can go wrong (ABCP fiasco?) and prepare for the next crisis by setting up the resolution authority and thinking about how it will be funded.

Angelo: a retroactive tax, based on banks' 2007 balance sheets, cannot be collected from the banks that failed. It can only be collected from the banks that survived.

That seems a little unfair on those banks that took smaller risks, or managed their risks more skillfully.

It would reduce the capital of those banks that survived.

The expectation that the same sort of tax might be imposed retroactively in future would worsen the moral hazard problem today, since you know you will pay the tax if you are careful, and survive.

If the problem is you just need to pay the wages of the resolution authority: how is that normally done in cases of bankruptcy? Doesn't the trustee take first crack of the remaining assets of a bankrupt firm?

Curses! I just followed Angelo's lead, and posted my above comment on the wrong thread! (This is why financial crises happen in waves: we all just follow each other blindly!)

I just read the new Cochrane Op-Ed in the WSJ. Could you comment on that? Would be interesting to hear your view!



xch rate can easily go to 1.15 with no effect on inflation as most prices in Canada have not adjusted to reflect 1.00 to 1.05

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