Canadian Treasurer

July 15, 2011

Tepid U.D. recovery, mounting fiscal burden pose added risks for Canada

OTTAWA -- The current drama in Washington over increasing the U.S. debt ceiling and related conditions to reduce deficits is just the opening act in a long series of intense negotiations. There is no pain-free way for the United States  to deal with its excesses of the past, which has added to the risks for sustained growth in  Canada, according to a Conference Board of Canada briefing released today.

The extraordinary fiscal stimulus introduced during the 2008-09 recession to shore up the U.S. financial system was critical in stabilizing the U.S. economy and returning it to growth. But that same stimulus has left the U.S. in a deep fiscal hole.

"At some point, the President and Congress will have to rise above their current differences and level with Americans about exactly what will be required to bring America's fiscal problems under control," said   Glen Hodgson, Senior Vice-President and Chief Economist. "While the   United States  has more time to address these issues than desperate cases like   Greece  or   Ireland, it doesn't have forever."

"Moreover, a "lost decade" with mediocre U.S. growth would create further risk to the Canadian outlook, and add to the adjustment problems of Canadian sectors like automotive and forestry that have been heavily dependent upon exports to the U.S. market," said Hodgson.

The 2008-09 recession caused government revenues to shrink rapidly, while stimulus spending to help kick-start the U.S. economy added to the fiscal deficit. U.S. public debt accelerated from 40 per cent of gross domestic product (GDP) to over 70 per cent in just three years. Currently, federal revenues are only around 15 per cent of GDP, while expenditures are well above 20 per cent, creating a significant structural deficit.

Of the proposals put forward so far to address America's debt problems, the only realistic plan came from the bipartisan commission on deficit reduction created by President Obama. Released last autumn, the panel's plan combined tax increases and spending cuts to gradually narrow the gap between government spending and revenues. The Administration's own plan doesn't go far enough on the expenditure reduction side, while the Republican plan assumes that the problems can be solved without tax hikes. However, the panel's plan has failed to obtain serious consideration because it includes such unpopular - but arguably essential - measures as higher gasoline taxes and a national sales tax.

The Conference Board of Canada recently scaled back its forecast for U.S. growth in 2011. The after-effects of severe flooding, high gasoline prices, problems in housing markets, and disruptions in global supply chains linked to the Japanese earthquake and tsunami in March are contributing to a slowdown in economic activity. Although fairly solid growth is expected for the next few years, the risks to the forecast are much higher than normal. Overall, real GDP is expected to expand by 2.5 per cent this year and climb to 3.6 per cent in 2012.

The briefing, Facing up to the United States' Economic Challenges, outlines the implications of America's fiscal problems for Canada:

  • The economic outlook for   Canada  is generally positive but fraught with important external risks. Canadian governments must stick to the plans they have already introduced to balance their fiscal books in order to strengthen Canada's capacity to sustain external shocks.

  • Slower U.S. economic growth combined with U.S. fiscal problems would have a further negative impact on Canadian export growth to the U.S., which has seen its share steadily fall from a peak of 85 per cent in the early 2000s to about 70 per cent, due to the soaring loonie.

  • Canadian monetary conditions are still very expansionary; short-term interest rates are exceptionally low, aimed at helping the Canadian economy deal with the significant external turbulence. Yet inflation is creeping upward and the Conference Board expects short-term interest rates to increase - putting added upward pressure on the loonie and amplifying the need to use trade policy more aggressively to help diversify exports away from the U.S. market.

The brief concludes that Canadian business will have little choice but to re-double their efforts to adapt, innovate, diversify their sales, and internationalize their business model if they are to remain globally competitive.



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