Hey I got one right! .......but so did everyone else.

Real GDP (quarter-over-quarter annualized) came in at -3.4% for the second quarter, just a shade better than my forecast of -3.5% (I've been having problems with my forecast link not working so I've taken it down until I can figure out a better way to link to it -you'll have to just trust me on this one.)

For whatever reason there was quite a bit of (correct) consensus on the growth prospects for the 2nd quarter:

Actual: - 3.4
WCI (Stephen Gordon): -3.4%
BoC: -3.5
SMC (Me): -3.5
BMO: -3.3
RBC: -3.2
CIBC: -3.1
TD: -2.2
Scotia: -2.0

The one thing the above list ignores is vintage (which I'm too lazy to dig up right now). The last time I made a forecast was sometime in early July, while others like RBC and TD were mid-June.

Congrats to Stephen Gordon for nailing the number right on the head (I know yours was more of a preliminary estimate based on available 2nd quarter data, but still, kudos.)

WTF Econo-Journalism: CBC Edition

Okay, this is a minor complaint, but those are my specialty. While watching the news (CBC Vancouver) this evening, I overheard the anchor-woman say the following:

"Another sign that the economy is on the road to recovery - inflation in
July fell to its lowest level in years"

I've asked this before, and I'll keep asking, are there any editors anymore? I assume someone wrote the above for the teleprompter and someone else signed off on it. And yet, there is some blonde news anchor on my TV making an elementary mistake while projecting absolute confidence, leaving me no recourse but to scream obscenities at the ceiling.

Reconciling the Bank of Canada's forecast or the Importance of Exchange Rate Assumptions

In its most recent MPR, the Bank of Canada produced a growth forecast for 2010 that seems rather optimistic compared to some private sector forecasts:

Bank of Canada 3%
Merrill Lynch 2.7%
Bank of Nova Scotia 2.5%
Royal Bank of Canada 2.5%
Shock Minus Control 2.5%
Bank of Montreal 1.8%
CIBC 1.5%
Toronto-Dominion Bank 1.4%

One probable reason for the variance between my forecast and the Bank’s is the Bank's assumption of an 87 cent US/CAD exchange rate versus my model range of 87 to 95 cents. Indeed, I can account for quite a bit of the variance between my own forecast and the Bank's simply by tweaking the exchange rate assumption.

Of course, there any number or assumptions that could be driving this difference, particularly within a complex model such as TOTEM, the Bank’s primary forecasting model. However, the low exchange rate assumption does seem to be a pretty important one.

Canadian Economic Forecast 2009-2010

The Canadian economy will contract significantly in the first half of 2009 before giving way to a modest recovery in the third quarter. I anticipate that growth in 2010 will be given a boost from combined fiscal and monetary stimulus, but that overall economic growth in 2010 will be sluggish. Overall, I expect the Canadian economy to contract by 2.5% in 2009 before returning to positive growth of 2.4% in 2010. It is important to note that although I've forecast a strong rebound in quarterly real GDP growth in 2010, much of this growth will come from temporary sources such as government stimulus and the rebuilding of depleted inventories by Canadian businesses. Therefore, despite a return to positive quarterly growth, I expect that the economy will remain fundamentally weak, characterized by sluggish employment growth and an over reliance on government stimulus.

I expect the unemployment rate to peak around 9.2% before declining at a measured pace as the economy begins a slow recovery. The enormous amount of slack in the economy should keep core inflation well below the Bank of Canada’s 2% target for all of 2009 and 2010. Low inflation, along with a strong Canadian dollar, will allow the Bank of Canada to keep its conditional promise of holding its overnight rate at 25bps until the second quarter of 2010. However, if core inflation remains near target, the Bank may be eager to bring rates back to pre-crisis levels. The forecast suggest that the second half of 2010 could see the Bank increasing its overnight target by 100 basis points with the first increases announced in June or July.

I should note that this forecast assumes that the normalization of credit markets currently underway continues without further disruption and that GDP growth in the United States turns positive by the end of 2009 and remains positive but below trend growth in 2010. The forecast also assumes that the Canadian dollar stays within a range of 87-95 cents.

The recession is over!!...now about that recovery...

Canada has had three severe recessions in the past 30 years; one in 1981, again in 1990 and the most recent one that began in the last quarter of 2008.

The 1981 recession was a classic “V” shaped recession and lasted roughly five quarters. It was also the second part of a double-dip recession, following a brief contraction in 1980. The recession of 1990 was a steep, extremely painful and protracted “U/L” shaped recession, and was followed by a very weak recovery.

The Bank of Canada made some noise this past week after the release of its latest Monetary Policy Report (MPR) predicting an end to the recession in Q3 of this year. If the Bank’s forecast is correct (remember that it is a forecast, not an official statistical release) then the 2008 recession would go into the books as the shortest of the past three Canadian recessions.

The following figure illustrates the path of the Canadian economy 12 quarters after the business cycle peak prior to the recession for 1981 and 1990 along with the recent Bank of Canada forecast.



So where does the BoC expect the recovery to come from? Three places – Personal Consumption Expenditures, Government and Inventories. See below from the July MPR

I have my doubts that PCE will really be that strong coming out of this recession. THe unemployment rate is liklely to approach 10% and household saving is rising in response to massive wealth destruction from falling equity and home prices over the past year. However, indicators such as retail sales and consumer confidence do seem to be improving, so perhaps the Bank is right.

The real difference maker in the expected recovery from the 2008 recession, compared with past recessions, is the fiscal policy response of the Canadian Government. Government spending in the year following the end of the 1981 recession contributed just 0.3% to real GDP growth and only 0.2% to real GDP growth in the year following the end of the 1990 recession. In contrast, the BoC estimates that Government spending will add 1.3% to growth in 2010.

Given that inventory rebuild is estimated by the Bank to add 1% to growth in 2010 and you have 2.3% of the 3% growth forecast estimated to come from temporary sources that may not do much for job creation. Add an uncertain outlook for the Canadian housing and non-residential construction sector and it would seem like we have a recipe for a jobless recovery in 2010. But at least the recession is over...right?

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Baby Induced Blogging Hiatus

Mrs. Shock Minus Control gave birth to our third boy this morning - blogging will be light for a while.