Thank you very much, Chair, and thank you to the members for this invitation.
Good morning everyone. Paul and I are pleased to appear before this committee to discuss the Bank of Canada's perspective on the current state of the domestic and global economies.
Let me state at the outset that the speed and synchronized nature of the recent global downturn has resulted in a heightened degree of uncertainty, which is evident in the diverse views on the outlook. Indeed, it is safe to say that the degree of uncertainty—the range of possible outcomes—is greater than the range of point forecasts. It is in this environment that considerable policy actions are being taken globally: the provision of liquidity to stabilize global financial markets, the write-down of assets and the recapitalization of institutions, and macroeconomic policy measures to boost aggregate demand. A considered and coherent perspective on the likely success of these policies importantly shapes our view of the outlook for the global and Canadian economies.
The outlook for the global economy has deteriorated significantly in recent months. What began last autumn as a relatively controlled slowdown has become a sudden, synchronized, and deep global recession. The proximate cause was the intensification of the global financial crisis, owing to both the failures of several prominent global financial institutions and the growing realization that this was a solvency rather than a liquidity crisis.
The recession that originated in the United States is now spreading globally through confidence, financial, and trade channels. In the process, the inevitable correction of unsustainably large current account imbalances in several major economies is now under way. For example, we project that the U.S. current account deficit will narrow to 3% of GDP in 2009, about half of its size two years ago.
The sustainable rebalancing of global demand from deficit countries such as the U.S. and the U.K. towards surplus countries such as China and Germany will take some time and is likely to dampen the pace of global growth during that period. In the bank's January Monetary Policy Report Update, we projected that global economic growth will be tepid this year, at just 1.1%, before rebounding mildly to a below-trend rate of 3.7% in 2010. As part of that projection, we expect that the eventual U.S. recovery will be much slower than usual. For example, we project that it will take two and a half years from the onset of the recession for the U.S. GDP to return to its pre-recession level. This sluggishness reflects the lingering effects of the financial crisis on the U.S. financial system and the slow recovery of domestic consumption there owing to the magnitude of wealth effects and the deterioration of their labour market.
Reflecting the seriousness of the shock, the global macro-economic policy response has been unprecedented. Monetary policy rates have been substantially and rapidly reduced in most major economies. Fiscal policy initiatives have also been robust, with the world well on its way to spending an average of more than 2% of global GDP in discretionary fiscal measures. These measures will replace some of the lost private demand and, equally important, will create a window for the necessary rebalancing of global growth.
Simultaneous fiscal action is not only more powerful than measures taken in isolation but also has the potential to provide some support for commodity prices. However, given the typical lags, the effects of these monetary and fiscal policies will increasingly be felt over the course of this year and into 2010.
The global downturn and the declining demand for our exports will make this a very difficult year for Canada's economy. We are now in recession, with GDP projected to fall by 1.2% this year. The first half of the year will be particularly challenging, with sharp falls in activity and sharp increases in unemployment. Unfortunately, last Friday's employment report is broadly consistent with our outlook. The 14% drop in our terms of trade since July will translate into a significant reduction in Canadian incomes, and thus in our ability to sustain real domestic spending. Losses by Canadians in their financial holdings, either directly or via their pension plans, and their concerns about the employment outlook will also restrain domestic consumption this year. Uncertainty about the economic outlook and strained financial conditions should lead to declines in investment spending this year.
As some of you may have noticed, in our base case projection, real GDP is expected to rebound in 2010, growing by 3.8%. Though seemingly impressive when viewed from the depths of a recession, such a recovery is actually more muted than usual. This recovery should be supported by several factors: the timeliness and scale of our monetary policy response; our relatively well-functioning financial system and the gradual improvements in financial conditions in Canada next year; the past depreciation of the Canadian dollar; stimulative fiscal policy measures in Canada; the rebound in external demand in 2010, particularly in emerging markets, and the associated firming of commodity prices; the strengths of Canadian household, business, and bank balance sheets; and the end of the stock adjustments in residential housing.
A wider output gap and modest decreases in housing prices should cause core CPI inflation to ease through 2009, bottoming out at 1.1% in the fourth quarter of this year. Total CPI inflation is expected to dip below zero for two quarters this year, reflecting year-on-year drops in energy prices. The bank views that the possibility of deflation in Canada is remote.
Indeed, with inflation expectations well anchored, total and core inflation should return to 2% in the first half of 2011 as the economy moves back to its production potential. Of course, global developments pose significant upside and downside risks to the inflation projection, and the bank judges that these risks are roughly balanced.
As I noted at the outset, in the current environment the bank's projections and those of all forecasters are subject to an unusually high degree of uncertainty. As we have consistently emphasized, stabilization of the global financial system is a precondition for economic recovery globally and in Canada. To that end, throughout the world policymakers have acted aggressively and creatively. Central banks have provided unprecedented liquidity to keep the financial system functioning. Last October extraordinary steps were taken by all G7 countries to prevent systemic collapse and to promote the effective functioning of money and credit markets.
However, the task is far from complete. Decisions taken in the coming weeks in the United States and in other major economies to isolate toxic assets in order to create a core of “good” banks will be critical. In addition, G20 countries need to act in concert to improve domestic and international regulatory frameworks. In this regard, measures to improve transparency and integrity to implement a macro-prudential approach to regulation and to adequately resource the IMF are vital.
If these national and multilateral measures are not timely, bold, and well executed, Canada's economic recovery will be both attenuated and delayed. The reality is that the financial crisis and the subsequent recession originated beyond our borders and the necessary triggers for a sustainable recovery must be found there as well.
Canada has much to offer to these efforts, which is why the bank is working closely and tirelessly with our international colleagues.
At home, the Bank of Canada has acted decisively. We have eased monetary policy by 350 basis points since December 2007, including 250 basis points since the start of October 2008. In doing so, we cut rates deeper and sooner than most other major central banks. With the strains in our financial system considerably less than elsewhere, monetary conditions have eased significantly in Canada since the start of the crisis. In fact, we are entering this recession with negative real interest rates—an unprecedented situation. In time, this will have a powerful impact on economic activity and inflation.
Guided by Canada's inflation-targeting framework, we will continue to monitor carefully economic and financial developments in judging to what extent further monetary stimulus will be required to achieve the 2% target over the medium term. The bank retains considerable policy flexibility, which we will use if required.
To conclude, in challenging times such as these, people rightly look to a few constants, to institutions that they can rely upon and to certain expectations that will be met. Canadians can rely on the Bank of Canada to fulfill its mandate. They can expect inflation to be low, stable, and predictable. The relentless focus of monetary policy on inflation control is essential in this time of financial crisis and global recession and it remains the best contribution that monetary policy can make to the economic and financial welfare of Canada.
With that, Chair, Paul and I would be pleased to take questions.
