The Bank of Canada made the extraordinary move of omitting eagerly awaited new economic projections from its quarterly Monetary Policy Report on April 15, saying that forecasting can’t be done “with any degree of confidence” in light of the uncertainty surrounding the COVID-19 crisis. The Bank of Canada replaced its customary baseline projection with a “scenario analysis” of plausible outcomes that depend on how long it takes authorities to get COVID-19 outbreaks under control. 

The Bank of Canada’s focus is on the present, which contains all the information policy-makers need to realize that they have an epic fight on their hands. The central bank also unveiled a new set of emergency measures, including plans to create tens of billions of dollars in order to purchase provincial bonds and corporate debt. At the same time, it left the benchmark lending rate at 0.25%, underlining the central bank’s reluctance to adopt negative interest rates.

“The Canadian economy is experiencing a significant and rapid contraction,” Governor Stephen Poloz said in a statement. “The shock is a global one, affecting all countries, but commodity-producing countries like Canada are being hit twice. In the very near term, policy-makers can do little more than cushion the blow.” 

Canada’s central bank hasn’t closed its forecasting shop. On the contrary, the economic analysis division is probably working harder than ever, as staff incorporate new data sources to make better guesses on how the future might unfold.

For example, Poloz told reporters that China’s experience with re-opening its economy could hold information about how the future will unfold in Europe and North America. The Bank of Canada observed that road and subway traffic in China is back to pre-crisis levels during the week, but remains down on weekends, suggesting a hesitancy to return to life as normal.

The Bank of Canada was also willing to warn the public to brace for a terrible spring. Gross domestic product in the second quarter could be between 15% and 30% lower than it was at the end of 2019, the central bank said in its latest quarterly economic report.  At the same time, inflation could drop to zero, as spikes in prices for certain goods, including food, are outweighed by dirt-cheap gasoline and the disinflationary pressures that will come with broadly weaker demand.

The Bank also announced new measures to provide additional support to Canada’s financial system. The Bank said it will start buying up to $50-billion worth of provincial debt in the “coming weeks,” along with $10 billon of investment-grade corporate bonds in the secondary market. Both are firsts, and both will expose the central bank to tricky political considerations, as provincial and corporate leaders could see such support efforts as an opportunity to delay difficult decisions. 

But the persistent strain in credit markets trumps all such considerations for now. Provinces, particularly those that count on oil revenue, are especially at risk at a time when they will need to increase their borrowing to support their health-care systems.

“Liquidity, not moral hazard, is the watchword of the day,” said Kyle Hanniman, an assistant professor at Queen’s University in Kingston, Ont., who studies public debt. “Going forward, however, is another story. Even if programs are meant to be temporary, several provinces may come to be very dependent on federal support.”

First things first. The hundreds of billions of dollars that governments and the central bank are pushing into the economy could create the conditions for a relatively fast recovery. Many of the newly unemployed are in industries that are used to high rates of job turnover, suggesting those companies could be up and running fairly quickly once the lockdowns end. “In this less severe and less persistent scenario, the decline in economic activity is abrupt and deep but relatively short-lived,” the Bank of Canada said.

Unfortunately, there is an equally plausible scenario in which the recession changes the nature of the economy, resulting in sluggish growth for a considerable period of time. Companies could go bankrupt and not come back, or employers could decide to carry on with reduced head counts, thereby increasing unemployment. “These effects could cause structural damage to the economy that might not be undone for several years, if ever,” the central bank said.

Source: Financial Post
Source: Financial Post
Source: Globe & Mail