Unfortunately, this trend probably won't end any time soon. With business investment slowing markedly, the growth in personal expenditures declining and Canada's public sector poised to cutback on hiring during budget season, it's doubtful that things will improve in the short-term.
But what about the longer term? Here too, there isn't much to be optimistic about. The reason for that is because, within the next few years, households will embark on a period of deleveraging during which households will seek to pay down debt and increase savings, as recently highlighted by the Governor of the Bank of Canada. And when households reach that point, the economy will likely encounter a considerable setback that will lead to weakening employment growth. This will be especially apparent if businesses don't increase their level of investment and exports stay at their current levels. Public sector austerity and deficit reduction will only worsen the situation.
To illustrate this point, I thought it would be useful to include the following charts showing the rate of unemployment along with Canada's household sector balance (click on charts to enlarge)*. As you can see, the rate of unemployment and the household sector balance tend to move in tandem: whenever the household sector balance trends upward (downward), the unemployment rate rises (falls).
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| Chart 1, Source: Statistics Canada |
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| Chart 2, Source: Statistics Canada |
Now, it should be pointed out that this relationship runs both ways. On the one hand, higher (lower) unemployment reduces (increases) household spending, and, one the other hand, increased (reduced) consumption by households helps to boost (weaken) the economy and increase (decrease) employment.
But given that growth in consumer credit is at the lowest it's been in over two decades and that owner's equity as a share of real estate is declining rapidly (which reduces households' ability to finance consumption using equity in their homes, see chart 3), it seems reasonable to believe that it's the rise in the household sector financial balance that will create upward pressure on unemployment rather than the other way around.**
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| Chart 3, Source: Statistics Canada |
To conclude, the implication here is that the federal government's intention to move forward with austerity at this time is ill-advised. Unless the decline in the household sector's participation in economic growth is not offset by that of another sector (government, foreign or business), weak employment growth will likely last longer than most people expect.
* A sector's net financial balance is the difference between sectoral savings and investment. Reduced household consumption and investment, as well as higher savings increase the financial balance of the household sector.
**For those who are interested in this type of analysis, I strongly recommend the work of economist Josef Steindl. According to Steindl, the examination of sectoral financial balances provides a useful framework for the analysis of macroeconomics. Also, Steindl viewed the household sector's propensity to save as an important determinant of economic growth.
Reference:
Steindl, Josef. 1982. “The Role of Household Saving in the Modern Economy”, Banca Nazionale del Lavoro Quarterly Review, Vol. 35, no. 140 (March), pp. 69-88
Hi Circuit. This is an interesting post with a clear message. I have not seen this approach applied to the unemployment problem anywhere. Stephen Harper wants people to work more when they are older (he's increasing pension age). Reducing unemployment today means more work now.
ReplyDeleteNod Circuit! You're right on course.
ReplyDeleteLeveraging and de-leveraging is a function of available opportunities and appropriate collateral to compensate risk. Owner's equity is a great measure of solvency; but terribly dysfunctional in lagging security markets and real estate markets especially when with a macro background where sovereign deleveraging is undergoing an experiment. Linking up the critical elements on the one chart was quite innovative and the correlations can't be denied. I hope Ottawa takes a good look at the implications before continued rise in unemployment in both private and public sectors lays waste the household sector. We'll have to thank the US for fueling Canadian momentum, certainly not Parliament.
I don't remember the last time I heard a critical voice in Parliament directed toward federal fiscal policy. It probably dates to the early 1990s when the (brilliant) former Minister Doug Peters (an economist by trade) testified in Committee that deficit reduction at that stage in the recovery (Canada was still recovering from the 90-92 recession) would only lead to even larger deficits, as it would reduce private sector income. It was a fine move, as far as Government members go. Now, even opposition parties are incapable of uttering such bold truths. Even the social democrats have blindly adopted the balanced budget credo.
ReplyDeleteInterestingly enough, in recent history, UK politicians seem to have demonstrated more courage. For instance, at the time the UK government was in a fiscal surplus in the early 2000s, some UK MPs criticized the (then Labour) Government of taking away well-earned funds (via taxation revenues exceeding expenditures) from tax-payers and businesses (a criticism that's consistent with the circuitiste approach to economics).
Swells: You got it. It's been the modus operandi of the federal government in recent years to free-ride on US expansionary policies and claim it as the result of domestic policy action. Indeed, the US should be thanked for the recent boost to Canadian exports. But, as you know, the huge current account surpluses of yesteryear are a thing of the past. The Obama Administration has its own interest to look after. The US is committed to narrowing its export gap. In the 1990s, Canada benefited from Clinton's strong dollar policy. JH Craw was right in a recent comment: a weak CAD was the best boost to Canada's economy.
well thanks for the nod circuit but there were excellent policymakers at Finance, and some brilliant officials at BoC that appreciated the value of a more subdued CAD, especially when manufacturing was steering towards asian coasts. unfortunately some are now 'retired' (lol)and others long gone.
ReplyDeletei'm not certain that the US (esp democrats) wants to reduce its positions with Canada. even some republicans are willing to accept a deficit with Canada if it alleviates asia's hold on the us economy.
as far as brilliant civil servants I would add to Peters (nod!) someone that is perhaps the most brilliant of them all Eric Kierans. his take on state intervention in the canadian economy after years of opposing rival Walt Gordon's 'economic nationalism' is worth a look; as is his recommendation to Levesque that 'true' independence can only be secured with 'control over one's currency', position similar to Parizeau's at the time.
on the other hand,and towards your own excellent! take (handy synopsis with the chart)on the case of the canadian household sector and its consequences, i also like the findings of Cox & Whitley BoEQ a few years ago on the UK and the Fed's Dynan& Johnson on the US.
Thanks for the note and BoEQ and Fed references. My colleagues and I wasted no time tracking these articles. As for the likes of Kierans and Gordon, no one in any of the several legislative assembly compares to these individuals today, I'm afraid. Mind you, my comment referred to the post-1990s Parliament. Also, I don't deny that there were good officials at Finance in previous decades. Starting with Robert Bryce in the 30s, Finance always had its share of good Keynesians and sensible pragmatists. From what I understand, Bryce even tried to got Lerner into Finance. (Can you imagine the challenges involved in implementing functional finance in such a decentralized federation?!)
DeleteGreat comment re Levesque, Parizeau and independence. Here's a related anecdote: I recall that during the "debate" on the fiscal imbalance (the biggest non-event in Canadian fiscal federalism) back in the mid-2000s, Parizeau was the only person in Canada who put the finger on the real issue. Parizeau explained during an interview that the fiscal imbalance really had nothing to do with fiscal tax room or the increasing divergence in program costs between the provincial and federal government (as most commentators and politicians suggested at the time). Rather, according to Parizeau, the main source of the "imbalance" was that Ottawa had access to a central bank whereas the provinces did not. I recall chuckling at this statement. Of course, he makes a good point. As far as I know, no one else ever looked at the issue from that angle.
Just a quick clarification to the above comment: Parizeau wasn't saying that access to the central bank causes a fiscal imbalance; rather, he was saying that the central bank grants the federal government "an immense advantage" over the provincial governments in regard to financing.
DeleteTo some good posts and comments, a few add-ons: I concur that Congress would not object to seeing a reasonable trade deficit with Canada. It's ironic because most deficits are generated by sectors whelming with US subsidiaries. I think the more unsustainable position is the lack of resolve and foresight by your Parliament to recognize the writing on the wall that is permeating European Austerity Stage: It doesn't generate the results expected at a macrolevel. In fact, recent negative outlooks by some rating agencies on the UK especially suggest that notwithstanding the cuts in spending, the lack of growth imperatives compromise the fiscal balance.
DeleteI agree that Canada has had its great share of remarkable and outstanding civil servants. In my opinion Kierans was by far the most visionary, yet most politically expendable (most serious error your Privy Council ever made). Unfortunately, he left the diamonds on Ottawa desks, and fortunately for some of his American counterparts, we picked them all up. I would only add to your own commendation of Bryce-the man did harbor a brilliant teacher (Keynes) and a brilliant supporter (Diefenbaker) but moreso influenced some brilliant colleagues and "Ottawa men" among which Rasminsky who I consider having had a major role in designing Canada's presence on the international financial scene and MacKintosh who gave your civil service its present style.
As far as Levesque/Kierans, Scotland/UK deliberate the same trade-offs as the latter. Joining 'someone else's' currency zone restricts and compromises fiscal optimality and balances, and raises the problematic of whether BoE (any other central bank) can act as a LOLR for Scottish borrowers (national institutions).
GC, the austerity experiment at this time is a real mistake. You're right to point out that the writing is on the wall. A recent NY Fed staff paper by Denes et al. does a good job at explaining the problems with austerity at the moment:
Delete"How does the budget deficit react if the government tries to balance the budget by cutting government spending, i.e. via "austerity measures" popular in many countries in reaction to the budget deficits stemming from crisis of 2008? The model suggests that under reasonable parameters, the budget deficit increases rather than decreases. This occurs because the cut in government spending leads to a reduction in aggregate output, thus reducing the tax base and subsequently reducing tax revenues. Our result is thus akin to being on the "wrong" side of the famous "Laffer curve" where cutting tax rates increases revenues by increasing the tax base. Here we see, instead, that cutting government expenditures can increase the deficit due to the shrinking of the tax base, so that even if the government is now spending less, the amount of money it collects via taxes drops by even more."
http://www.newyorkfed.org/research/staff_reports/sr551.pdf
Also, our discussion on the 'Ottawa men' reminds me of a good paper dated a while back by Richard Nimijean: "Deficits and Debt: An analysis of the attitudes of Canadian Finance Ministers, 1940-1990".
As far as I know, there were some great economists in those days. And I'm not denying that there are still some really good ones today. But my impression is that today's economist has forgotten the tried and tested policies of the past, and has given too much currency to the theoretical insight based on rational expectations and approaches of the sort.
On a final note, I seriously suggest that the Liberals and NDP look to Kierans' and Peters' ideas today. The ideas of 'sound finance', which gave the appearance of optimality in the 90s and 00s, have reached a dead-end.
Excellent discussion by all.
DeleteThe nature of a Parliamentary democracy usually entails a great civil service. Someone should write on the topic, circuit. In turn, it ensues that the emergent is the rise of great civil servants and I am quite at ease in promoting Canada's financial types in this regard. We have to thank Canada for Galbraith of course.
But no one has to thank you for everyone. A recent article from one of your junior ministers (Maxime Bernier) was sent to my attention. I assume it was intended as a jive on US policy history. It is remarkable that staffers could have drafted such a document, and that your cabinet permit the issue of such an historically shallow exposé, although its only pretense to substantive form is a few dates and the names of a few presidents. I presume that the staffers be replaced and the minister be reprimanded for having published such fragmented 'rubbish' Obviously, this will not prejudice my admiration for your civil service, only for your Communications people that let the piper free.
I would only suggest that someone remind the skew-minded the consequences of austerity in Mexico ('94), Indonesia('98) and Argentina ('02)and look at the Euro-Area at the moment. This of course excludes one Balkan experiment in '02 that almost crushed an entire region.
I commend you on being up-to-date on the NYFed's February SR. DEG is an excellent piece and under normal circumstances should have been circulated to your people in Ottawa in time to prempt the publication by the minister. I know that JH and swells will not rebuff for obvious reasons. You or JL should indulge the misreps and misleads.
Correction on above: before last paragraph.
DeleteBaltic rather than Balkan, my apologize...it's age and age.
I did see Bernier's article and wondered the same thing as you did: Why on earth did the Minister agree to sign such an article?
DeleteI know Bernier is trying hard to sound like a libertarian, but I'm amazed he would prefer Japanese deflation over government deficit spending (largely borrowed domestically). Also, speaking of deflation, the comment on Warren Harding was a surprise. Perhaps Bernier is on a one man battle (along with the free-market Austrians) to rehabilitate the standing of the 29th US President. If so, Bernier should have educated himself on the role of the Fed during this time, as well as the temporary hiatus of the gold peg. The next step in all this is probably painting a positive picture of Mellon, the man behind the roaring 20s. Interestingly, the WPost recently had a piece praising Harding's austerity. As for the quote by Morgenthau (taken straight from Jr's Wiki page...), perhaps Bernier is not aware of Morgenthau's involvement in the mistake of '37. Balancing the budget really improved the economy, didn't it? Well, I guess we shouldn't be too surprised of the reference to Morgenthau: it's true that the Tories are drinking the same Koolaid these days.
I read the article with the same dismay as most. I always assumed that Ministerial posts for public consumption were always channeled for approval. This one was either a surprise or permitted. If the latter, then I assume we'll be in for some other adverse economic slips.
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