Mortgage Logic

Bank of Canada Fears Weak Growth in Economy

Jeremy Torobin, Globe and Mail

It’s almost a cliché that neither advanced nations nor emerging markets are doing all they can to fulfill all the commitments they’ve made at Group of 20 summits to close yawning imbalances in the global economy, preventing a smoother, faster recovery.

Few economic forecasting shops, though, have anything like the highly sophisticated models the Bank of Canada uses to map out all kinds of scenarios and predict the future, which helps policy makers assess what to do with interest rates.

This gives the central bank a hard-to-match bully pulpit from which to warn of the possible consequences if, for instance, rich countries like the United States and much of Europe do too little to attack their budget and trade deficits, or if emerging giants in Asia refuse to relax capital controls or allow their currencies to appreciate more quickly. Or if one side does too much while the other does too little.

And the bank’s latest research on the likely effects of continued foot-dragging and/or unco-ordinated implementation, released Thursday, paints a disturbing picture.

Essentially, global economic output would be 8 per cent -- or $6-trillion (U.S.) -- less by 2015 if a range of G20 commitments reinforced late last year at a summit in Cannes, France, are not implemented. U.S. gross domestic product would be 6 per cent smaller, while China’s GDP would be 12 per cent smaller, the bank said.

“Fiscal consolidation in the United States and Europe, flexible exchange rates and structural policies to stimulate domestic demand in the emerging-market economies of Asia, and structural reforms in Europe and Japan,” the central bank said in a quarterly recap of its latest research, “could lead to balanced economic growth and an orderly resolution of global imbalances over the medium term.”

Delays, meanwhile, could have “severe negative consequences,” leading to “a significantly weaker global economy” and a less stable global financial system.

Moreover, if the U.S. and Europe move aggressively to reverse their deficits but emerging markets fail to take measures to offset the plunge in global demand that could result from that, world economic activity would be 7 per cent lower in 2015.

The clear message here is both sides of this delicate dance not only need to do their part but, just as crucial, they need to co-ordinate their efforts.

“Aggressive fiscal consolidation in advanced economies that is not accompanied by flexible exchange rates and structural reforms in the emerging-market economies of Asia, as well as by growth-enhancing reforms in Europe and Japan,” a team of five researchers at the bank said, “could lead to even weaker growth in global output and near-term deflationary pressures.”

A lot of this will sound familiar to anyone who follows global economics from the point of view of the Bank of Canada. Governor Mark Carney also chairs the Financial Stability Board, a G20-linked body tasked with making international finance less of a threat to the wider economy, so he has spoken on these issues many times and outlined the potential benefits of adopting stricter banking rules.

But the message about global co-ordination is still timely.

As my colleague Kevin Carmichael reported last week, efforts to rebalance the global economy -- which everyone agrees is crucial to reducing the likelihood of another crisis -- have hit a wall. Europe’s crisis is flaring up again, the U.S. election is drawing nearer and China’s economy is slowing more quickly than expected. All of which suggests the prospects for global co-operation for the greater good, as opposed to each region going it alone for political and economic survival, aren’t great.

Chinese imports barely grew in April, causing the country's trade surplus to balloon to $18.4-billion (U.S.) from $5.3-billion the previous month, indicating that consumers and businesses in the faster-growing emerging markets are still not ready to pick up the slack from Europe and the U.S. That spells trouble if the trend continues, because this time next year both the U.S. and Europe will be in the thick of brutal fiscal restraint that may not be carefully choreographed.

China, until recently, had made strides in narrowing its current-account surplus (which reflects the country’s over-reliance on exports as opposed to domestic spending). But now a wider Chinese trade surplus, and a U.S. trade deficit that grew 14 per cent in March, are replicating the imbalanced global economy that was too weak to withstand the ripple effects of the U.S. subprime-mortgage collapse.

The U.S. itself is now a more balanced economy that relies less on debt-fuelled spending. But it is smaller and weaker than it was at its pre-crisis peak, and will probably never regain that past form. So its ability to drive global growth is limited.

The Bank of Canada’s research is a stark reminder of why the two leaders of the world economy need to work together and get this right, or both will suffer.

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