Two 'what ifs' about Canadian macroeconomic policy during the recession

There's a lot for econobloggers in the US and Europe to get exercised about. They are facing serious problems, and their policy makers have demonstrated an alarming inability to deal with them. It's harder for Canadian econobloggers - okay, for this particular econoblogger - to put together arguments documenting how Canadian policy makers got things terribly wrong and what should be done to get us back on track.

So instead, I'm going to consider two "what ifs?" where Canadian policy-makers could have - but happily did not - get things terribly wrong.

The first scenario is: what if the Bank of Canada's 'conditional commitment' to hold interest rates low had not been enough? In retrospect, it looks as though the Bank dealt with the recession as well as could be expected. In March 2008, the first interest rate decision made while Mark Carney was Governor was to cut the overnight rate target by 50 basis points, in the expectation that the US economy was in for a rough ride. And when the Bank hit the zero lower bound, it moved on to unconventional measures, starting with the the 'conditional commitment' in April 2009 to hold the policy rate at the lower bound for at least one year. This turned out to be all that was necessary; the Bank moved away from the lower bound in 2010.

Output and employment started recovering in mid-2009. But what if they hadn't? Would the Bank of Canada have followed the now well-worn path set out by the Bank of Japan and the Federal Reserve?

My own guess is no: the Bank was clearly preparing itself for a round of quantitative easing in the spring of 2009, and the necessary legislation that would have permitted it to widen the range of assets that it could purchase was passed. I don't think they really knew exactly what assets they were going to have to buy or in what quantity - who did? - but they had something the other central banks didn't: an explicit political mandate. If the Bank thought that the only way to reach its inflation target was to use its steamroller to flatten the yield curve, it had - in principle - a free hand to do so.

I can think of less rosy scenarios - what if the government decided to overrule the Bank and force Carney to resign? - but I think they are much less probable.

The other scenario involves fiscal policy. The Economic and Fiscal Statement of November 28, 2008 is best remembered for its provision to cut the subsidies to political parties, and this provoked the 2008 prorogation crisis. But it is less well-remembered that the initial instinct of the Conservative government in the face of the crisis was fiscal austerity (see especially Table 2.2 here).

As it happened, part of the Conservatives' strategy for winning the next confidence vote involved accepting fiscal stimulus as part of the plan to deal with the recession. Canadian fiscal policy - federal and provincial governments together - more or less followed the textbook recipe: strong growth in expenditures during the recession, cutbacks during the recovery. This stands in sharp contrast with what happened in the US:

My what-if question here is: what if the Conservatives hadn't thrown in that provision to eliminate the subsidy to political parties? If the opposition parties weren't so concerned with their own finances, would they have still joined forces and obliged the newly re-elected Conservatives to back down from its austerity program? I'm not so sure they would have.

Sometimes I wonder how much of our good fortune in the recession was due to the Conservatives' inability to resist the temptation to kick their opponents when they were down.

 

 

Comments

[hosertohoosier]

A. The legwork for the coalition was already under way prior to the 2008 fiscal update. Canceling party subsidies may have been the spark, but there was gunpowder all over the floor from the day Harper failed to win a majority.

B. The Harper government planned a stimulus, they just hadn't crafted their plan by November 2008 (about a month after winning the election, and before the extent of the crisis was clear). What government would pass up the opportunity to spend money or cut taxes, targeting swing voters in the name of a national emergency? The fiscal update would have limited the ability of federal workers to strike, and rolled back civil service pay increases, but that doesn't strike me as indicative of a broad pro-austerity agenda. Rather it seemed more a sign of where the Tories wanted to distribute any gains/losses from a stimulus.

[Saturos]

Two words: Sumner Critique.

[Nick Rowe]

An important post Stephen. We dodged a bullet. We won't always do so. My thoughts:

1. Monetary policy. Things could have been worse for the BoC. Yes, I think you are right that they would have responded even more aggressively, if it had been needed, to get inflation back up to the 2% target. But we still had a recession. And looking at the graphs of the CPI and NGDP you did for my old post strongly suggests that NGDP targeting would have been better, because we can clearly see the recession when we look at NGDP, but can hardly see any recession when we look at CPI.

We might not always dodge the bullet. And with the Eurozone seeming to be falling apart and entering a second recessions, we still aren't really out of the woods. We are too complacent. I think we should switch to NGDPLPT now.

2. Fiscal policy. My memory of the politics is a bit different. As far as I can remember, in 2008 there was very strong cross-party support, and support across the population, for the idea that it took us all a lot of pain to get the federal budget under control in the 1990s, and that budget deficits were tabu, and that any party that undid all that good work and didn't run a budget surplus would be violating a sacred trust. And I can remember that meeting in Toronto Stephen Harper had with a couple of dozen economists, asking for advice. And him coming out of that meeting saying he needed to run a deficit. With hindsight, I'm pretty sure he had already decided that of course he needed to run a deficit, and just needed us for political cover. And then after he announced deficit budgets, the Liberals giving him a lot of flak in parliament for doing so.

I don't think Harper was pushed into loosening fiscal policy by the opposition.

But yes, it could have been different. The "what if" that concerns me more on fiscal policy is slightly different. What if the Liberals (with Conservative support) hadn't seriously tightened fiscal policy in 1995, and hadn't got the debt/GDP ratio down so low by 2008 that loosening fiscal policy wasn't a big deal?

[Nick Rowe]

Saturos: the Sumner Critique (that if the central bank is serious about targeting inflation or NGDP then monetary policy is all that's needed and the central bank will offset any change in fiscal policy so the fiscal multiplier is zero) is probably correct, in my view. But "probably" isn't always good enough. If the downside risk is big enough, and fiscal ammunition is cheap enough, there is a lot to be said for giving the bear both barrels at once, just to be sure it's dead, even if you think the monetary barrel is probably all that's needed. And in Canada, unlike the US, the Federal debt/GDP ratio was low and falling going into the recession, and there was no "structural" (in the political sense of "structural" -- i.e. deep-seated) deficit. So fiscal ammunition was cheap. We were going to need to loosen fiscal policy eventually anyhow, to prevent the debt/GDP ratio going negative. 2008 seemed like a good time to do some of that loosening, on micro grounds as well.

[Stephen Gordon]

The "what if" that concerns me more on fiscal policy is slightly different. What if the Liberals (with Conservative support) hadn't seriously tightened fiscal policy in 1995, and hadn't got the debt/GDP ratio down so low by 2008 that loosening fiscal policy wasn't a big deal?

Yikes. Yes indeed.

[Bill Long]

Kind of vague .. and I'm too time pressed to look it up ... But I recall
that even prior to the infamous fiscal update the PM had committed to
a stimulus program at a G8 or G20 (in,I think Peru). The fiscal update
in question showed no indication of that. To the contrary it was primarily
a list of political nasties.

[David Andolfatto]

Great post, Stephen.

I am wondering, however, what role the real estate market played in each of these scenarios? If you were to redraw your picture, replacing G with P (real estate prices), I think we know what we would find. So the question is whether Canada was saved by a fortuitous increase in G, or a fortuitous lack of decline in P. (Or a combination of both, and of other factors as well...)

[Mike Sax]

Geez the main thing I get from all this is that Nick and Steve you guys are lucky to live in Canada where every your conservatives aren't nearly so reticent. Agreement and consensus sounds easier to come by.

As far as monetary policy is concerned this is just one more exhibit to my thesis that we should not a la Ron Paul "End the Fed" but we should end the Fed's "Independence."

It's amazing from our experience that the CB in Canda-and to an extent in Britain-follows the lead of the political authorities. That would be one import I'd welcome.

[Andrew F]

Huh?

The Bank of Canada is much less politicized than the Federal Reserve. You didn't see Mark Carney having to testify to grandstanding politicians. The worst that happened was he was used as a prop in a photo op to show that the government was Serious About the Economy.

The mandate of the Bank of Canada is a political decision, but their execution of that mandate is not.

[Mike Sax]

All this inspired a post

Turns out the grass really is greener in Canada http://diaryofarepublicanhater.blogspot.com/2012/06/canadas-policy-sometimes-grass-really.html

[Determinant]

Nick's statement that we aren't out of the woods yet is one reason why I thought eliminating 16K federal public servants was gratuitous and unnecessary. Unlike the 1990's there isn't a clear growing sector for that employment to migrate to, unlike tech at that time. In fact Nortel picked up a lot of former Public Servants during the 1990's cuts because it was based in Ottawa and Ottawa has 40% of the federal Public Service.

Geez the main thing I get from all this is that Nick and Steve you guys are lucky to live in Canada where every your conservatives aren't nearly so reticent. Agreement and consensus sounds easier to come by.

As far as monetary policy is concerned this is just one more exhibit to my thesis that we should not a la Ron Paul "End the Fed" but we should end the Fed's "Independence."

It's amazing from our experience that the CB in Canda-and to an extent in Britain-follows the lead of the political authorities. That would be one import I'd welcome.

It's the structure of the legislature/executive. In the UK and Canada we have Westminster style parliaments where the executive (PM and Cabinet) are drawn from the House of Commons and explicitly responsible to it. Responsibility means three things: First, if a government cannot pass a money bill, it must resign, that is a vote of non-confidence. Second, the Government alone can introduce money bills (it's called the Royal Recommendation). Third, Ministers are responsible for the actions of their Departments to Parliament, get questioned about this daily and get hauled in front of committees regularly for it. So there is every encouragement for a Department to fall in line with the Minister and a Minister to "mesh" with his/her Department.

The Confidence Convention means that essentially the constitution hold a guns to Parliament's head to come to an agreement about spending in particular and most other things. If a bill is rejected, the PM has every right to go to the Governor General and ask for a snap election. That has happened often enough in Canadian history.

The American "Checks and Balances" system means that Congress and the President don't have the gun held to their heads to come to a compromise quickly.

[JP Koning]

Regarding timing, the IMPP was announced in early October 2008, preceding the 2008 prorogation crisis by a few months.

[Mike Sax]

Thanks for that primer Determinant.

"The American "Checks and Balances" system means that Congress and the President don't have the gun held to their heads to come to a compromise quickly. "

Again it really does sound almost utopian compared to our system. Checks and Balances sounds nice and there are some virtues in it but what we mostly have gotten lately is perpetual gridlock.

As far as Nick's point that next time Canada may not be so lucky of course this is logically true but really you guys aren't well known for deep depressions-as far as I'm aware. Wasn't the Great Depression even midler for Canada?

[Stephen Gordon]

Regarding timing, the IMPP was announced in early October 2008, preceding the 2008 prorogation crisis by a few months.

Yep. The November fiscal update expected the IMPP to be a source of additional revenues on top of whatever cuts they could make.

[Determinant]

It's just different.

The downside is that with a majority the Prime Minister can get most everything he wants. If you don't like it, the Opposition can make a fuss and that's actually what they do, but there is very little they can do to stall a bill the government wants for an extended period of time.

Further the ability and desire of a governing party to hold itself to account when it dominates committees and has a working majority in Parliament is decidedly small.

A PM with a majority has been called a kindly dictator and such a PM has sweeping powers and control that a President doesn't have and never has.

The other part is that the US has the "spoils system" where most of the senior positions in the US Civil Service are presidential appointees and are explicitly political. The Fed is an exception. In Canada and the UK the senior Public Service is merit-based, doesn't change with the government and is (mostly) apolitical. In a Department there is a Minister (political), that Minister's political staff and advisors, the Deputy Minister (senior Public Servant, e.g. Sir Humphrey Appleby of "Yes, Minister") and the non-political Public Servants to actually administer things.

The line between politics and the Public Service is clearer in Canada and Departments are left to carry out their agendas. Setting those agendas, though is a political question and while formerly Departments did a lot of that too, nowadays Ministers, parties and think-tanks do this more than the Public Service does.

As far as Nick's point that next time Canada may not be so lucky of course this is logically true but really you guys aren't well known for deep depressions-as far as I'm aware. Wasn't the Great Depression even midler for Canada?

No, the Great Depression was even worse in Canada in terms of unemployment than in the US, and we didn't have a New Deal (crazy political story, but what was attempted got caught in politics). But then as now, your banks failed and ours didn't.

We did get the "War Kick" earlier though, since we declared war on Germany in 1939.

[Mike Sax]

Of course i Know it's compicated-I was kinda tongue in cheek in calling it a Utopia-LOL. The irony is that had we rather than you declared war on Geramny in 1939 rather than 1941 Hitler probably wouldn't have gotten as far as he did.

Overall interesting stuff.

[Kosta]

Nice post Stephen,

What caught my eye was your chart. In particular it is interesting that while the Canadian government spent a lot more on goods and services that the U.S. (about 7%/year), the Canadian GDP is only 2% higher after three years. That's quite a bit of stimulus for quite paltry results. Is this an argument against fiscal stimulus?

[Jacques René Giguère]

Harper would have gone with austerity. And sorry, but Carney would not have been able to revive demand jsut with monetry means. I am with Determinant regarding the inability to reassign peoples. Not counting the housing crash. The only good result would have been the 2012 election where the people, having understood once again that "Tory times are hard times" would have crushed them for the next 70 years, as we did last time.
Maybe Mulcait will pull it in 2016.

[Simon van Norden]

Thanks for this post, Stephen; the Nov. 2008 budget update that you linked to was a useful reality check for me. As for the political consensus at the time (Nick's point), IIRC the english-language leaders debate during the campaign (late Sept. 2008, after Lehman Bros. collapsed) featured all 5 party leaders (yes, even the greens) solemnly swearing that, if they formed the next government, they would *never* run deficits.

I recall this particularly because
(1) this seemed like spectacularly stupid economic policy; the US recession was in its 4th Q by this point and the US banking panic was in full stride, making it plain that things were about to get worse.
(2) within weeks, every one of the five party leaders had changed their minds. So much for being able to debate economic policy during an election campaign. (Sadly, Kim Campbell was right; an election campaign is no place for serious discussions.)

I guess Harper was the last to change his view. I'm not sure whether that makes him more principled or more ignorant.

[Stephen Gordon]

Yes indeed. I just went through the WCI archives for the time and came up with this post, which notes in bafflement how Stéphane Dion was obliged to back away from an entirely sensible admission that the federal govt might run a deficit if the economy tanked.

[Lorenzo from Oz]

The "what if" that concerns me more on fiscal policy is slightly different. What if the Liberals (with Conservative support) hadn't seriously tightened fiscal policy in 1995, and hadn't got the debt/GDP ratio down so low by 2008 that loosening fiscal policy wasn't a big deal? Then you would be the UK.

It also suggests a slogan to use to Keynesians -- support reducing public debt in good times, it makes fiscal stimulus cheaper in bad times! Oh, wait, that is what Keynsian fiscal policy is suppose to look like ...

Why the political intricacies are different, the general story is very familiar to an Australian, only we did even better.

[Lorenzo from Oz]

That should have been "while the political ...".

On promising no deficits, surely that is political signalling -- I won't (re)debauch the public finances! The Gillard Government has delivered (sort of) a small fiscal surplus in Oz just for that reason even though some commentators are arguing more fiscal stimulus is appropriate (I don't agree, but the political dynamics is the point here).

If you publicly accept the framing that low public debt is good and so permanent deficits are bad (hence "no deficits!" because they are bad), then even if circumstances lead to you to temporarily stray into deficit territory you are still signalling that you will get things back to "how they should be" (because deficits are bad as they run up debt). Hence the Harper Conservative government in Canada and the Gillard Labor Government in Australia acting in similar ways (at least in terms of general fiscal policy and rhetoric).

[Steve]

Not sure how well this fits in, or even if it is relevant; but does the Canadian climate also factor into the fiscal stimulus effect. The usual joke here is there are two seasons, winter and construction. This is blindingly obvious in my area of Alberta. This translates itself into a backlog of planned work that is 'shovel-ready' and can be easily be pulled forward with cash if there is labour capacity. There certainly seemed to be a lot more work being done in the national parks in the last few years than I remember.

[Saturos]

Yeah, so Scott just responded here: http://www.themoneyillusion.com/?p=14691

I think this (in the comments) undercuts Nick's argument: "Saturos, I’m also not 100% sure they can hit NGDP targets, but that doesn’t matter. I am 100% sure that they can hit expected NGDP targets, and if expected NGDP is on target, why do fiscal stimulus?". Which leaves only the "micro" argument in the main post.