Canada in the Financial Crisis

Carmen Reinhart and Kenneth Rogoff recently published a short paper comparing the path of five US variables in the current financial crisis with the average performance of the same variables during five major crises in other countries - Spain (1977), Norway (1987), Finland (1991), Sweden (1991) and Japan (1992). The five variables chosen were asset prices (real home and equity prices), real economic growth, the current account and public debt. The authors set the crisis year to time "t" and track the variables for 4 years prior (t-4) and 3 years post-crisis (t+3).

I enjoyed this approach so much that I thought I would steal it and apply it to Canadian variables. The graphs that follow use 2007 as the base year for the financial crisis. Unfortunately, I don't have the Reinhart and Rogoff data set so the only comparison I'm able to show is with the US.

(Click to Enlarge)























The results are pretty interesting. Canadian asset prices seem to be following the same path as the United States ( my chart doesn't show it, but Canadian home prices softened in 2008 and should fall in 2009). Also, real growth is declining rapidly.

A key difference between Canada and the US, and perhaps a difference that will have meaningful implications for longer-term recovery, is that at the time the crisis hit, Canada had a much stronger budget and trade balance. Yes, public debt will grow as a result of the stimulus package and yes our trade balance is suffering as Canada's terms of trade weakens but the point is that Canada was in much better shape to withstand the crisis.

In crude terms, we could afford the crisis whereas the United States, partially because of reckless fiscal policy and partially due to a savings glut, could not and will now find it much harder to claw its way back. The lesson, and contrary to the immortal words of Dick Cheney, deficits matter.