Saturday, January 31, 2009

2009 Revision and 2010 Forecast

Posted below is my 8 quarter forecast slightly revised for Q4 economic data and some model tweaks. I still expect 2009 to be quite weak, with average year-over-year growth of -1.3%. Also of note, I am now forecasting 4 quarters of negative growth from 2008Q4 to 2009Q3. If all goes well, the 2009 recession will be followed by a healthy recovery in 2010 with real GDP growth of 2.2% for the year, and over 3% in the second half. This 2010 forecast puts me more in the optimistic Bank of Canada camp than those pessimists at the IMF.

(Click to enlarge)

-0.7% Real GDP in November

Ouch. Before the November release I had Q4 2008 coming in at around -2.4%. I think that forecast is probably still going to be about in line with the actual Q4, though maybe more reflective of the low-end of a range of -2.4% to -3.0%.

I was surprised by the better than expected Q4 GDP in the US (if you can put a positive spin on the biggest contraction since 1982). Real GDP came in at -3.8% vs expectations of -5.8%. Barry Ritholtz points out that much of the upside surprise came from higher than expected inventories. Higher inventories in Q4 should mean production cuts shifting into 2009 and therefore even weaker growth in Q1.

Not good times - bad times.

I'm hoping to post a revised Canadian forecast later today to reflect the released budget and incoming Q4 data. Stay tuned.

Tuesday, January 27, 2009

Budget Impressions

After days of leaks, we finally get to see the whole thing. The Government claims that stimulus spending of 1.5% and 1.1% of GDP in 2009 and 2010 respectively will lead to 1.9% and 1.4% in increased GDP for a total of 3.2% over two years (watch this space for 2009 and 2010 forecast updates) Based on a quick reading of the budget, here is how I would break it down:

Good Policy:

Infrastructure spending: I can see Stephen Gordon's point - but I still think that infrastructure spending will provide some stimulus - and at least maintain demand for, if not create, construction jobs.

Access to Credit: $5 billion to the BDC, EDC to keep credit flowing to viable small businesss seems like money well spent. The additional $50 billion for the Insured Mortgage Purchase Program to purchase mortgage backed securities from banks is also a good idea.

Tax Cuts: meh - I'm sure I could find a lot of "middle-class" people that make over $80K. Hopefully the individuals targeted will spend the extra $200-500 instead of funneling it into TFSAs.

Retraining - not really stimulus, but I think necessary if Ontario is going to finally wise-up about the prospects of its Manufacturing industry.

Political Pandering Masquerading as Stimulus Policy:

Social Housing: This is not politically correct, but to me spending on social housing or housing on reserve land is simply pouring money into what Hernando de Soto termed "dead capital".

Bad Policy:

$7.5 billion for forestry, autos and manufacturing - rewarding failure and years of underinvestment. Not good use of taxpayer money.

Credit Card Interest Relief as Stimulus?

This caught my eye this morning over breakfast. Interesting...I'm not sure about this but I'll have to read the full details when the budget is released. More later...if I have time, its a busy week.

Thursday, January 22, 2009

How Effective will Projected Deficit Spending Be?

The BoC released its updated monetary policy report today, forecasting a significant 4.8% contraction in the economy in the first quarter of 2009 and an overall average annual contraction of 1.2% ( Calculated as the average year-over-year growth rate). The BoC is a little more pessimistic about Q1 growth than I am, and much more optimistic about a second half recovery. I’m not sure where the recovery is going to come from but my guess is the BoC’s model includes significant stimulative effects from a year of historically loose monetary policy as well as substantial Canadian and US fiscal stimulus.

Few details about the composition of the Canadian stimulus are known, though it was leaked today that the Canadian Government is going to run a deficit of approximately $34 billion for at least two years. A deficit that large amounts to a little over 2% of GDP which is in accord with the general consensus for the recommended size of a stimulus package.

The composition of the stimulus, between spending and tax cuts, may have important implications for a second half recovery - unfortunately, as Nick Rowe points out, there is very little agreement on the effectiveness of spending vs. tax cuts. A recent OECD study by Roberto Perotti, using the SVAR approach of Blanchard and Perotti (2002), revealed that a tax cut in Canada equal to 1% of GDP provides a boost to the economy of about 0.3% after 4 quarters and 1.8% after 12 quarters. However, a 1% increase in Government expenditures actually leads to a small decrease of in GDP after 4 quarters and a cumulative decrease of about 2% after 12 quarters.

Does this mean that there is no room for government spending in the Jan 27. budget? No. Given the state of credit markets and investment conditions, it is unlikely that government investment would be displacing private investment. Moreover, while I would like to see permanent middle class tax cuts compose a significant portion of the budget, the down-side is that we may see much of the tax relief funneled into the new TFSA's - not a bad thing for the long-run but not great as stimulus.

The Government has a very difficult task ahead, lets hope they get it right.

Tuesday, January 20, 2009


So not so bold.

The Bank sees the economy contracting by 1.2% in 2009 and inflation not returning to target until 2011.

Saturday, January 17, 2009

Will the BoC cut to zero on Tuesday?

Perhaps. It would be a bold move, but perhaps not bold enough. I would still like to see the Bank attack credit spreads directly by purchasing commercial paper assets.

For what it's worth, my forecast
of GDP and core inflation suggests that a zero target for two quarters is the right policy under a conventional Taylor Rule.

The above path for the overnight rate assumes a significant output gap (>5% in Q12009) and core inflation close to 1%. Alternatively, if deflation is going to a problem, the BoC should go to zero on Tuesday and start thinking very creatively about how to engineer non-negative inflation expectations.

Friday, January 16, 2009

Energy Export Cliff Diving?

During oil's run to $150, Canada enjoyed enormous receipts from energy product exports. These receipts reached about $35 billion in Q2 and Q3 2008 and since Canada is a net exporter of energy, energy receipts greatly helped our overall trade surplus.

So what happens now that oil has fallen to $40? A (very) simple model of the elasticity of energy exports with respect to a one quarter lag of the price of crude oil (I know we export more than oil, but I already told you the model was simple) suggests that energy exports are about to fall off a cliff.

Look out below!

Tuesday, January 13, 2009

Canadian Quarterly Economic Forecast 2009

One of my objectives in starting this blog was to keep a record of my own economic forecasts (with the recognition that economists have a fairly pitiful forecasting record). Moreover, I haven't been quite satisfied with my initial crack at forecasting the Canadian economy in 2009. Here I present a revised quarterly forecast (though I'll stand by my original numbers for the contest).

As shown in the table, I am forecasting that the economy will be in recession for at least 3 quarters, from 2008Q4 to 2009Q2 with a real possibility of the recession extending into 2009Q3. Importantly, this forecast assumes government stimulus of 0.5% of GDP in 2009Q3 and 0.5% in 2009Q4 - that is, a stimulus package proposed in the January budget will take several months to impact the economy. This is an entirely arbitrary assumption, but one I can live with. Based on the most common number thrown around in the media I've assumed total stimulus of 2% of GDP, spread equally across four quarters (this is almost certainly wrong but maybe close enough). Without this stimulus, I would project that the recession would last through 2009Q4.

Without further ado, I present the inaugural Shock Minus Control forecast:

So how does my projected 2009 recession compare with past Canadian recessions? If my forecast is close, it should be fairly deep but perhaps not as drawn out as 1981 or 1990:

Sunday, January 11, 2009

Bad sign for domestic demand?

If a severe recession is to occur in Canada, it will have to be home-made. A 1% shock to growth in the United States translates to about o.33% in Canada and so even a very severe contraction in the US may not be enough to drag the Canadian economy into a deep recession if domestic demand holds up. However, recent construction data shows that may be a big if.

Residential and Non-Residential investment in structures is clearly softening. Recent building permit data show declines in permits and housing starts have been trending sharply lower for many months. However, it is not the direct impact of the slowing construction sector that has me concerned - investment in structures is only about 10% of GDP - its the potential impact on employment, and therefore personal consumption, from a slowing construction sector. As Stephen Gordon points out, unemployment in the construction sector is at an all time low and construction currently occupies about 7% of the labour force, well above historical average levels.

Seasonally adjusted construction employment fell by 44,000 jobs from November 2008 to December 2008 - if this trend continues, and I think it will, it will be much harder for the economy to escape with only a short and shallow recession.

Friday, January 9, 2009

Is Jeff Rubin becoming a counter-indicator?

It seems to me that, in the past year or so (maybe more), investors taking the opposite trade of every idea that Jeff Rubin has had would have outperformed the market substantially.

If that is true, this may be bad news for North American equity markets

Tuesday, January 6, 2009

Flaherty, Flaherty, Flaherty...

After all his blustering about bank lending, Jim Flaherty has now seen the light - tight borrowing conditions in Canada are not due to reluctant banks, but rather tightness in other segments of the credit market - particularly commercial paper. Corporate paper spreads are still too high (see figure to the right), even for quality borrowers, and buyers of securitized commercial paper have lost their appetite for asset-backed products.

Until credit markets return to normal and investors have regained confidence in the quality and transparency of securitized products, the only real option for alleviating short-term funding costs may be for the Bank of Canada to begin buying commercial paper. Marc Carney seems willing to get creative so I'd hope to see this happen sooner rather than later.

Now, I'm not very political and so please don't read it that way, but why has it taken so long for the Finance Minister to figure all of this out? Moreover, it seems that he has been consistently behind the curve on economic issues. First there was the disastrous and totally out-of-touch economic update which was followed by a rapid about-face on deficit spending and then he goes and picks a wrongheaded fight (that he rightfully lost) with Canadian banks. Perhaps it is time for a cabinet shuffle?

Monday, January 5, 2009

Consensus Forecasts: Bloggers vs. Bay Street

As a follow up to the Great Canadian EconoBlog Forecast contest, I thought it would be interesting to compare the opinions of Canadian economics bloggers with the pros on Bay Street. The charts below compare the mean forecast and range of forecasts for 4 of the macro-variables in the contest made by Bloggers and Bay Street (I didn't have time to gather TSX forecasts from the Banks). The sample includes TD, CIBC, Scotia, RBC, and BMO (apologies to National Bank, I couldn't find updated forecasts on your website). The sample of bloggers includes myself, Nick and Stephen from Worthwhile Canadian Initiative, Mike Moffat, and Andrew from Stackelberg Follower. I know others made forecasts but if I couldn't see a link to a blog, you weren't included.

It is interesting that the variable that is the hardest to forecast, the exchange rate, has an appropriately large range (78 cents to 94 cents) and that this range is almost identical between groups of forecasters. Moreover, the Banks would seem to be slightly more bullish on growth, hence the BoC target close to 1%, than the bloggers consensus of only about 0.5%. Other than that, it is generally agreed that inflation will be too low and unemployment too high.

Friday, January 2, 2009

Canadian Econoblogosphere Forecasting Contest 2009

The fellas over at Worthwhile Canadian Initiative have thrown down the proverbial gauntlet - here are the rules:

1. Unconditional point-forecasts only, for 5 macroeconomic variables: CPI, Unemployment Rate, US/CAN Exchange Rate, BoC Target, TSX (My forecasts are the product of a small-scale model so I'll throw in a real GDP forecast as well).
2. Only those who have made a forecast will be allowed to laugh at others' forecasts in January 2010.
3. No prize for the best forecast (other than bragging rights).
4. "Best" forecast is defined as that which minimises the following loss function:
Loss = sum of absolute value of [(forecast-actual)/latest available end of 2008 actual].

Here is what I think is in store for 2009:

CPI Inflation: 0.6%
Unemployment Rate: 7.1%
US/CAN Exchange Rate: 94 cents (with bias downward)
BoC Target: 0.75% (just to be different)
TSX: 8780
Real GDP Growth: -1.7%

That was fun, great idea guys!