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.

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.

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.

50bps

So not so bold.

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

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.

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!