A Federal Budget Designed for the TimesThe Economic Action Plan of 2009 • Christopher Ragan • McGill University • and • Department of Finance • May 7, 2009
Outline of Talk • Global Economic Context, January 2009 • Canadian Economic Context, January 2009 • Three Key Budget Themes • Final Bits • -- no politics
Global Economic Context, • January 2009
A collapse in the U.S. housing market … • U.S. Housing Starts and Months Supply of Existing Homes • U.S. S&P/Case-Shiller Home Price Index per cent, year over year thousands, at annual rates level, months supply at current sales rate Housing Starts (left scale) Months supply of existing homes (right scale)
… led to losses in U.S. banks and huge write-downs worldwide. U.S. Write-downsand Losses Global Write-downsand Losses Exceed $1 trillion Billions, USD Billions, USD Source: Bloomberg. April 17, 2009
What was initially viewed largely as a problem of liquidity… • …became a problem of systemic stabilityafter the fall of Lehman Brothers on September 15.
Equity markets contributed to the global financial carnage. World Equity Markets IMF’s Estimates of Financial Sector Potential Writedowns (2007-2010) % change since January 1, 2007 Billions, USD *Europe includes Euro area and the U.K. Source: IMF’s Global Financial Stability Report, April 2009. Source: Bloomberg. Up to and including April 24, 2009.
Credit spreads increased sharply… • Credit Spreads basis points Notes: These spreads are a measure of banks’ funding costs relative to a risk-free rate and are a gauge of financial market stress and banks’ financing pressures. The rate on the overnight-indexed swap (OIS) is used as a proxy for expected overnight rates. LIBOR is the London Interbank Offered Rate. CDOR is the Canadian Dealer Offered Rate. Daily data up to and including April 24, 2009. Source: Bloomberg.
… and (with a lag) affected credit growth. • Credit growth Year-over-year percentage change historical averages: 1992-present Source: Bank of Canada.
Central banks were aggressive and also “creative” in their actions. • Policy Interest Rates • Capital Injections • Troubled Assets Relief Program • Direct investments in financial institutions, e.g. Barclays, ING, AIG, Fortis • Guaranteeing the liabilities of financial institutions • U.S., Ireland, U.K. • Nationalization • Fannie Mae, Freddie Mac, Icelandic banks • Purchase of “toxic assets” • Public-Private Investment Fund, Asset Protection Scheme (UK) • Supporting financial markets • Commercial Paper Funding Facility, Term Asset-Backed Securities Loan Facility, Canadian Secured Credit Facility • Global actions to support the financial sector per cent Sources: Bank of Canada, U.S. Federal Reserve, European Central Bank and Bank of England.
Financial markets and the “real” economy? • Can we really speak of the financial sector separately from the “real” economy? • Economists were soon reminded of the importance of credit to production and employment.
Industrial production in major economies slowed sharply ... and then fell off a cliff! • Industrial Production Year-over-year percentage change Source: Bank of Canada.
We were faced with the first synchronized global recession in over sixty years … • World Economic Growth per cent IMF’s threshold for a global recession Actual Forecast Note: World real GDP growth on a purchasing-power parity basis. Source: International Monetary Fund World Economic Outlook, April 2009.
… with considerable uncertainty about the global economic outlook. • Mean of Private-Sector Forecasts for 2009 Real GDP Growth per cent per cent Date of forecast Source: Blue Chip Economic Indicators - January 2008 to April 2009.
The knowledge that recessions triggered by financial stress tend to be longer and deeper … • Duration and output loss Source: IMF World Economic Outlook, April 2009.
… led to an internationally coordinated response. • G-20 Commitments: • Restoring global growth by coordinated fiscal actions and a full range of monetary policy instruments. • Strengthening the financial system by the introduction of stronger regulation and improvements to international cooperation. • IMF recommendation to provide fiscal stimulus of 2 percent of GDP.
Canadian banks were less leveraged than banks in other developed countries … • Bank Leverage Ratios assets as a multiple of capital Note: Based on data for the big six Canadian banks, seven major banks from the Euro area, six major UK banks and five large U.S. commercial banks. Canadian data are based on the regulatory ratio of assets (including some off-balance sheet items) to adjusted Tier 1 and Tier 2 capital. Leverage for other countries is measured as the ratio of balance sheet assets to shareholders' equity. Sources: Bloomberg; financial statements.
… and were also more highly capitalized … • Tier 1 Capital Ratio • (Tier 1 capital as a percentage of risk-weighted assets) Source: Bloomberg and bank financial statements
… but the global credit crisis was still affecting credit markets in Canada. • Business Lending Conditions balance of opinion, percentage points Tightening Easing Note: Pricing conditions refer largely to the cost of borrowing, whereas non-pricing conditions refer to access to credit and lending terms. The balance of opinion is calculated as the weighted percentage of respondents reporting tightened credit conditions minus the weighted percentage reporting eased credit conditions. Source: Bank of Canada - Senior Loan Officer Survey.
Household balance sheets were in better shape in Canada than in the United States … • Net Worth to Personal Disposable Income • Household Debt to Net Worth ratio ratio Source: U.S. Federal Reserve Board, Statistics Canada. Sources: Statistics Canada; Department of Finance.
… but the decline in consumer confidence still pointed to some likely retrenchment. • Consumer Confidence Index, 2002=100 for Canada, 1985=100 for U.S. Sources: The Conference Board of Canada; The Conference Board. *2009Q2 data is preliminary as it includes only April 2009.
Canadian public finances were in good shape … • Federal Net Debt • Total Government Net Debt to GDP Ratio per cent of GDP per cent Actual Forecast Sources: Department of Finance; Statistics Canada. Public Accounts basis. Source OECD Economic Outlook (March 2009 update); Department of Finance calculations. National Accounts basis.
… but that could not shield Canada from a U.S. recession. • U.S. Real Final Domestic Demand and Canadian Real Exports Growth per cent In 2008, 73% of Canadian exports went to the U.S. Sources: Statistics Canada; U.S. Bureau of Economic Analysis.
World commodity prices had collapsed … • Commodity Prices (in U.S. dollars) index 1997=100 index 1997=100 Source: Department of Finance Commodity Price Index. Note: April 2009 includes data up to April 24, 2009.
… Canada’s exports had declined sharply … • Exports and Imports Levels $ billions, annual rates Exports fall by 10% in Q4; imports fall by 2%
… real income (GDI) had declined sharply … Growth Per Capita Real Gross Domestic Income per cent U.S. up just 7.3% over the same period; over 15% in Canada Sources: Statistics Canada; Department of Finance.
… and employment losses had already begun. Unemployment Rates Employment Rates per cent per cent * Calculated using U.S. methodology. Sources: Statistics Canada, U.S. Bureau of Labor Statistics.
(My) Three Themes: • Financial-Market Measures • The Dual Need for Fiscal Stimulus • The Importance of Fiscal Prudence
Theme 1: Ensuring a Sound Financial System The Government had taken some actions in 2008 to strengthen the financial system. Budget 2009 established the Extraordinary Financing Framework, containing several measures.
Canadian monetary policy had already been very aggressive … • Target for Overnight Interest Rate per cent
Canada U.S. … but rate reductions had not always been reflected in credit markets … • Change in Interest Rates Since September 2007* basis points Policy Rates 1-year mortgage rates 5-year mortgage rates 10-year + corporate bond Basis points *As of the week of April 22, 2009.
Canada (left) U.S. (right) … and perhaps would not be sufficient anyway. • Consumer Confidence • Business Confidence Index, 2002=100 for Canada, 1985=100 for U.S. Index, 2002=100 diffusion index (50=no growth) Sources: The Conference Board of Canada; The Conference Board. *2009Q2 data is preliminary as it includes only April 2009. Sources: The Conference Board of Canada, Institute for Supply Management (ISM) non-manufacturing survey.
Theme 2: A dual need for fiscal stimulus 1. Dampen the economic slowdown 2. Protect the most vulnerable Canadians Suggested a targeted mix of spending and tax measures
Short-Run Expenditure and Tax Multipliers *Dollar impact on the level of real GDP after 8 quarters of a permanent one dollar increase in fiscal measures. Measures for low-income households include: all EI measures, training for non-EI eligible clients, wage earner protection program, increase to the National Child Benefit and Canada Child Tax Benefit, and enhancement to WITB.
New spending combined infrastructure and housing measures … • 1. Provincial, territorial and municipal infrastructure • Direct, low-cost loans to municipalities for projects • 2. Federal infrastructure • 3. First Nations infrastructure • 4. “Knowledge” infrastructure • PSE, CFI, electronic health records, broadband • 5. Social housing for low-income Canadians • 6. Support for home ownership and renovation
… with a variety of “sectoral” measures. • Capital Cost Allowance • Computers • Manufacturing and processing M&E • Tariff relief on machinery and equipment • Sectoral adjustment • Community Adjustment Fund • Support to automotive sector in collaboration with Ontario • Support for culture and the arts • Clean energy technologies • Support to small businesses
Income-tax cuts were aimed at low- and middle-income earners. • Significant personal income tax relief • Increases in basic personal amount • Increases to the National Child Benefit and Canada Child Tax Benefit • Doubling the tax relief provided by the Working Income Tax Benefit (WITB) • Reduction in MTR for very-low-income earners • 4. Increase to the Age Credit amount
Labour-market measures also figured prominently. • EI benefits strengthened: • Expansion of work-sharing • Extra five weeks of EI benefits • Additional benefits for participants in longer-term training • Enhanced availability of training: • Additional support for training programs • Targeted support for older workers • Apprenticeship completion grant introduced • EI contribution rates were frozen for 2009 and 2010
A $40 billion stimulus package (over 2 years) Tax measures account for $10.1 billion of total stimulus Spending measures represent $29.9 billion of total stimulus
Theme 3: The importance of fiscal prudence • The low debt-to-GDP ratio suggested to many that the government could have done much more than it did: • Bigger increase to spending • Bigger tax reductions or EI improvements • Could it?
Debt-to-GDP Ratio: 68 29 in 14 years • (Net) Debt-to-GDP Ratio per cent of GDP Projection Actual
Actual and projected budgetary balance • Budgetary Balance-to-GDP Ratio per cent of GDP Actual Projection
Can policies be scaled up or reversed? • 1. Infrastructure is difficult to scale up • 2. Tax cuts and EI changes are difficult to reverse • Government struck a balance between what was feasible and what was affordable over the medium term
Fiscal discipline will be necessary … … to ensure that G/GDP comes back to current levels in the medium term. … to repay the current deficits once surpluses return. … over the next 10 years to prepare for the coming fiscal challenges caused by demographic change.
The 2009 budget was designed to: • Improve Canadians’ access to credit and restore their confidence in the financial system; • Dampen the slowing effects of the global recession; • Protect and assist the most vulnerable individuals during these challenging times; • Retain Canada’s hard-won fiscal prudence so that we are prepared for future challenges.
Measures to accelerate Budget Implementation • BIA 2009 received Royal Assent on March 12th (compared to June 18th for BIA 2008) • Included $7.6 billion in spending authority for a range of measures, many of which would normally be funded through the annual appropriations process • Streamlined process for Cabinet and Treasury Board consideration and approval • New Central Vote in the Main Estimates allows for the release of Budget 2009 funds between April and June subject to Treasury Board approval • Spring Supplementary Estimates expected to be tabled in mid-May with supply obtained early June