Friday, November 28, 2008

Forecasting BC Economic Growth

Colin Hansen's Merry Band of Forecasters (eg. the BC Forecast Council) have revised their outlook for the BC economy in 2009 from real growth of 2.8% (Sept Vintage) to just 1.3% (November update).

Forecasting provincial growth is complicated by the fact that data is only available on an annual basis, which makes capturing the dynamics a little tricky. A model I have had some success with is a simple error-correction model with growth anchored to a trend with first differences in Canadian real GD, and global commodity prices. As shown in the figure, it provides a pretty decent in-sample fit.

In this framework the path of BC GDP growth will depend on the following factors:

1. BC Output Gap

Measuring potential output is imprecise at best but should be done using a production function approach. However the Bloated Hoarders of Valuable Information want a lot of money for capital stock data and I don't have a lot of free time so we'll have to leave that exercise for a later post. Therefore, I've taken the common approach of applying a Hodrick Prescott filter to BC real GDP. Using the filtered trend as a measure of potential output (or trend output if you find the atheororetical nature of the HP filter offensive), the BC economy has been operating well above trend for the last few years. I’d guess that in 2008 the economy fell below trend which would imply that the economy, all else equal, would be pulled up towards trend/potential.

2. Commodity Prices - After an incredible run, the price of practically every energy and industrial commodity has cratered. Witness the decline in the Scotiabank Commodity Price Index. The IMF projects that commodity prices are likely to fall 5% in 2009 -which to me sounds a little optimistic, but I’ve used it in the base

line scenario.

3. Canadian GDP Growth

Forecasts for the Canadian economy in 2009 are for growth at between -0.8% and 1.3 % - also likely too optimistic (I’ll discuss this more in a subsequent post). I would guess that BC would grow at a faster pace given its lower exposure to the United States and stimulus from the 2010 games.


Inputting these scenarios into my preferred forecast model returns a real GDP forecast for 2009 of 0.90% for 2009. However, stimulus from VANOC games preparation spending should generate an additional 0.4-0.5% growth. Therefore, I’ll go out on a limb and say that growth will land in a range of 1.3%-1.4% - about the same conclusion as the Merry Band of Forecasters - not sure if that inspires more confidence or less in my estimate, but I guess we’ll know for sure around this time next year. Stay tuned.


Marc said...

And down to 0.6% as of Friday. And only of them called for an actual recession for 2009. BC's outlook is pretty grim; the stats have only just begun to move in a negative direction but there is a potentially seismic shift in real estate about to unfold.

Remember BC's real GDP dropped 6% in 1982. The potential for a drop that is larger than Canada's in 2009 is more than 50-50. I think this other shoe will drop in the Jan-Feb time frame and will make for an interesting, if gloomy, backdrop to the election.

Oh, and welcome to the blogosphere. Who are you?

Shock Minus Control said...

I'm concerned about how imbalances in the BC economy (too much reliance on construction) will unravel as home prices cool.

Thanks for the welcome and thanks for dropping by. I'm an economist working in consulting in BC and that's about all I can say. (not trying to be mysterious but rather i'm not sure about my firm's blogging policy)

Marc said...

Here's what worries me: a reporter I know was talking to a developer at a Christmas party a few days ago. The developer needs to close on $400 M in condos by the end of the year, ie properties that were presold at 10-20% upfront, but now buyers are looking at closing at a 20% loss over what they paid with tremendous downside going into 2009. And many did not just buy one; they bought three. So the developer wonders whether the walk-away rate will be 5%, 10%, 25% or more, and whether they will need to put a large value of condos on the market in January so that they can make their own cash flow.

Just an anecdote but one strand of an increasingly common storm, and the potential for a seismic drop in home values that will have all kinds of adverse balance sheet impacts. Add to that construction jobs finishing and no work for the workers after that, and finance constraints. And and and ...

So I'm pretty gloomy about BC in 2009, and think most of the forecasters out there (who have a pretty bad track record to begin with) are in denial about how bad this storm could get.

Declan said...

I'm with Marc - if you update your forecast to reflect your concerns about B.C.'s reliance on construction and the cratering real estate market, I suspect you'll have a better forecast.

Shock Minus Control said...

I think there is sufficient stimulus in VANOC spending that growth in BC will stay above zero, but there is a strong possibility of growth coming in a lot lower than the 1.3-1.4% in my forecast.

Anonymous said...

In BC it'll be all about the housing. A colossal loss of paper wealth on the way, and a large slice of debt stressed citizens.

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