A Canadian flag flies in front of the Peace Tower on Parliament Hill in Ottawa on March 22, 2017.Chris Wattie/Reuters
Kevin Lynch was clerk of the Privy Council and vice-chair of BMO Financial Group. Paul Deegan was a public affairs executive at Canadian National Railway and BMO.
In its updated World Economic Outlook released on Tuesday, the International Monetary Fund is feeling a tad better about the global outlook for 2024 and 2025, with supply chains mending and commodity prices less frothy. Global growth is expected to continue on a roughly 3-per-cent pace this year and next, replicating last year. The IMF’s chief economist set the more upbeat tone, observing “the clouds are beginning to part,” with inflation moderating and a soft landing beckoning.
What did the IMF have to say about Canada? Its forecast for Canadian growth this year, at 1.4 per cent, is much higher than most Canadian private-sector forecasters. Official numbers on Wednesday lend support to the IMF’s view, showing the domestic economy regaining momentum.
As the government of Canada prepares for its 2024 budget, the updated IMF forecast carries some positive signals about the state of the global economy and some pointed messages about where fiscal policy should be headed in the future. They are messages that Canada should heed.
The main source of this relative optimism by the IMF is the strength of the U.S. economy, which grew a surprising 2.5 per cent last year and is anticipated to expand more than 2 per cent this year, coupled with American inflation moving back toward the target range more quickly than many expected given low unemployment and supply shocks.
The other factor is a double negative – the Chinese economy did not go into the feared deflationary spiral and growth has stabilized in the 4.5-per-cent range this year and is expected to slow again next year. Growth elsewhere in Southeast Asia and India is accelerating, with these economies showing great resilience to economic and geopolitical headwinds. The euro zone will avoid a recession, although growth will be tepid this year, and inflation is coming down earlier than expected, demonstrating resiliency to energy price shocks and the war in Ukraine.
To maximize the chances that the clouds do indeed part, the IMF was quite clear and pointed in its policy advice to governments.
First, finish the job on inflation. This will require a careful balancing act of not cutting rates too early and entrenching sticky inflation expectations, careful communications to anchor expectations that inflation will indeed move back to the target range, and reducing rates when inflation is moving inexorably toward target. The IMF is now assuming that central banks in major economies will begin to cut interest rates in the second half of this year provided inflation is on track to return to the inflation target.
Second, begin the job on fiscal consolidation. According to the IMF, “the answer is to implement a steady fiscal consolidation, with a non-trivial first installment. Promises of future adjustment alone will not do.” This is needed to rebuild fiscal resiliency to buffer future shocks and diminish rising debt levels given the escalating debt interest costs with high real interest rates. Fiscal restraint is also needed to complement the efforts of central banks to rein in inflation and create the environment for interest-rate cuts.
Third, ramp up structural measures to rebuild medium- and longer-term growth prospects. Global growth at 3 per cent is well below the average growth rate over recent decades, and this decline in trend growth is occurring in both advanced and developing countries. With it comes compression in living standards and fewer resources to meet public priorities.
This is certainly an acute issue for Canada, where our productivity performance is dismal, lagging the United States, which is our main market and competitor. Our medium-term growth prospects are mediocre. Combined with the unparalleled surge in immigration, Canada experienced a decline in our GDP per capita (standard measure of living standards) last year and is on track for an even larger decline in 2024. Hopefully the IMF message to capitals to focus on structural reforms to raise productivity and competitiveness is heard in Ottawa.
The IMF was also clear that, when inflation is back within its target ranges and monetary policy has loosened, interest rates are not going back to the levels we experienced over the 2015-22 period. The “free money mentality” that infected governments, businesses and households is ending. Equilibrium in real interest rates, consistent with the inflation targets, will be higher because of four trending forces: deglobalization, demographics, debt and decarbonization.
No IMF forecast comes without warnings of risks to the outlook, and this update was no different, although in a changed tone it indicated that “risks have moderated and are balanced.” The downside risks include further supply shocks, particularly shipping through the heavily travelled Red Sea, stickiness in services inflation, and volatility in financial markets which, particularly in the U.S., have priced in early interest-rate cuts predicated on rapid achievement of inflation targets. The IMF is also warning of the job dislocations that are emerging from the growing applications of artificial intelligence.
Meanwhile, Canada faces unique problems with inflation somewhat stickier than in the U.S., a lack of private-sector investment spending, a housing crisis, and a dramatic surge in immigration driving population growth and putting unsustainable pressures on social systems and housing.
All this is what Ottawa must not forget, even as a soft landing is in sight.