Flaherty’s Budget Cuts Presses Carney Successor on Growth
Finance Minister Jim Flaherty’s determination to balance Canada’s budget in two years increases the likelihood the government will lean on Mark Carney’s replacement at the head of the Bank of Canada to boost growth in the nation’s economy.
Flaherty’s plan to eliminate the deficit in time for elections in 2015 limits scope for further fiscal stimulus and increases the responsibility for the country’s next central banker to take the lead in responding to any economic slowdown.
“If you are going to be wedded to tighter fiscal policy, then you are sort of left with the need for weaker monetary policy” if the economy slows, said Mark Chandler, head of fixed-income strategy at RBC Capital Markets in Toronto.
The additional pressure comes as the Bank of Canada has been resisting joining Group of Seven peers such as the Federal Reserve in taking extraordinary measures to stimulate demand, even as the nation sees the slowest six months of growth since the 2009 recession. Canada’s central bank has been the only one in the Group of Seven signaling the potential for higher borrowing costs, in part because of concern that easing monetary policy would fuel household debt levels already at records.
Flaherty has said he would like to name a replacement in April, before Carney, 48, departs June 1 to take over the Bank of England a month later. Senior Deputy Governor Tiff Macklem, the most likely choice according to 10 economists surveyed by Bloomberg, said this week he’d accept the post if asked. The second-most likely candidate is Export Development Canada Chief Executive Officer Stephen Poloz, JPMorgan Chase & Co. said in a March 19 report, while the Globe and Mail newspaper said this week Stanford University finance professor Darrell Duffie is also a candidate.
Dan Miles, a spokesman for Flaherty, said by e-mail there is “nothing new to report” on the search process. Spokesman Jeremy Harrison also said the Bank of Canada had no comment.
At 1.5 percent, Canada’s growth this year will be the slowest among Group of 20 countries outside Europe, according to International Monetary Fund forecasts released April 16. The IMF also said Canadian policy makers should be prepared to take growth-supporting measures if the world’s 11th-largest economy continues to weaken.
Those measures probably wouldn’t come from fiscal policy. Flaherty, 63, has repeatedly said he plans to eliminate the country’s C$25.9 billion ($25.4 billion) deficit in the fiscal year that begins April 2015. Doing so would allow Prime Minister Stephen Harper’s Conservative government to implement previously promised tax cuts, which are contingent on the budget being balanced, before elections scheduled that year.
The Bank of Canada has also been clear that it’s not currently planning to loosen policy. The bank reiterated last week that higher borrowing costs “will likely be required” in the future as a strengthening U.S. lifts Canada’s outlook, bringing the country’s inflation rate to the 2 percent target and the economy back to full output in 2015. Policy makers also said their bias toward higher interest rates has helped cool a housing market they say has shown signs of overheating.
Fiscal policy may be a more efficient way to fuel growth than the “blunt” tool of monetary policy, because the government wants to spur companies to invest while keeping consumer debt in check, Chandler said.
“It seems to me the easiest way to unleash that may be through fiscal policy” such as investment tax credits, Chandler said.
Investors aren’t betting on higher interest rates. Trading in overnight index swaps shows no chance of tighter policy this year. The yield on Canada’s benchmark 2 year bond was 0.94 percent at 10:11 a.m. in Toronto, below the central bank’s 1 percent target for the overnight rate.
Still, the bank’s insistence that its next move will be to tighten policy has also probably prevented a depreciation of the Canadian dollar that would fuel growth and help exporters by lowering the cost of their goods abroad, said Andrew Spence, a managing director at the Ontario Municipal Employees Retirement System in Toronto.
Canada’s dollar has gained 28 percent from its lows during the 2009 recession and is up 57 percent since 2002. Exports, meanwhile, have yet to return to their pre-recession highs.
“I struggle to see where we are going to get sufficiently above trend growth to absorb spare capacity to meet the inflation target at this interest rate and at this setting of the exchange rate,” Spence, who worked as a special adviser at the bank in 2002 and 2003, said in a telephone interview.
Slower growth before the 2015 elections could undermine Harper’s message that he is a better manager of the nation’s economy, said Nik Nanos, president of Ottawa-based polling firm Nanos Research, in a telephone interview.
“Harper’s electoral success has largely been built on a brand related to economic stewardship,” Nanos said. “He hasn’t necessarily won because of his charisma or personal popularity. This will be crucial in the next election.”
One question the government may be asking the candidates is how long they are willing to tolerate inflation away from the central bank’s target, RBC’s Chandler said. Under Carney, the bank has stressed the flexibility of its monetary policy, which gives it extra time to bring inflation to target if it sees the need to counter an economic shock or deal with threats to financial stability.
Inflation has hovered near the bottom of the bank’s 1 percent to 3 percent target range over much of the past year.
“It’s probably a legitimate question to ask of an incoming governor: ‘How flexible will flexible inflation targeting be?,” Chandler said. “You could stretch that to say, ‘Does that mean in the current environment that we’re going to end up with something easier?’.”
Because management of the economy is the government’s strongest suit with voters, Flaherty and Harper will seek a candidate with whom they will feel comfortable working, Nanos said. “The last thing any government needs when the economy is fragile is a disagreement between the governor of the Bank of Canada and the government of the day.”
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