Past, Present and Future: TensePast, Present and Future: Tense

From crisis and recovery to long-term economic challenges

From crisis and recovery to long-term economic challengeslong term economic challengeslong term economic challenges

Christopher Ragan

McGill Universityand

C D H I tit tC. D. Howe Institute

January 27, 2011Lake Louise

1

Lake Louise

1 Fi i l i i d i1 Fi i l i i d i1. Financial crisis and recession1. Financial crisis and recession

2. Current recovery2. Current recovery

3. Looming challenges3. Looming challenges

2

1 Fi i l i i d i1 Fi i l i i d i1. Financial crisis and recession1. Financial crisis and recession

2. Current recovery2. Current recovery

3. Looming challenges3. Looming challenges

3

It began in the housing market ...

U.S. Housing Starts and Overhang of Existing HomesU.S. Housing Starts and Overhang of Existing Homes U.S. Home Price Index U.S. Home Price Index

20

per cent, year over year

2,400 12

thousands,at annual rates

level, months supply atcurrent sales rate

5

10

15

1 600

2,000

9

10

11

-5

0

5

1,200

1,600

6

7

8Housing Starts (left scale)

Months supply of existing homes (right scale)

-20

-15

-10

2001 2002 2003 2004 2005 2006 2007 2008400

800

J J J J J J J J J3

4

5

4

2001Q1

2002Q1

2003Q1

2004Q1

2005Q1

2006Q1

2007Q1

2008Q1

Jan2001

Jan2002

Jan2003

Jan2004

Jan2005

Jan2006

Jan2007

Jan2008

Jan2009

... and led to huge financial losses.

U.S. Write-downs and LossesU.S. Write-downs and Losses Global Write-downs and Losses Exceed $1 trillionGlobal Write-downs and Losses Exceed $1 trillion

90100110

Billions, USD

1200

1400Billions, USD

405060708090

800

1000

1200

010203040

p a e s y s 400

600

800

Citi

grou

p

nk o

f Am

eric

a

orga

n C

hase

ldm

an S

achs

orga

n St

anle

y

Mer

rill L

ynch

man

Bro

ther

s

0

200

5

Ban

JP M Go Mo

Lehm

Source: Bloomberg. April 17, 2009

World Canada U.S. Europe Asia

The shock in credit markets …

basis points

360

400Credit Spreads

240

280

320

360

Canada (CDOR - OIS)

U.S. (LIBOR - OIS)

Euro area (LIBOR - OIS)

160

200

240 Euro area (LIBOR OIS)

40

80

120

-40

0

Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09

6

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 the collapse of confidence …

Consumer Confidence Business Confidence

160

120

140

55

60

65

120

140

160Canada

U.S.

80

100

45

50

55

80

100

120

40

60

35

40

45

Canada (left)

U.S. (right)40

60

Index 2002=100

2098Q1 00Q1 02Q1 04Q1 06Q1 08Q1

30201978Q1 1984Q1 1990Q1 1996Q1 2002Q1 2008Q1

Index 2002=100 for Canada 1985=100 for U S

7

Index, 2002=100Index, 2002=100 for Canada, 1985=100 for U.S.

Sources: The Conference Board of Canada.

… caused industrial production to f ll ff liff

Year-over-year percentage change

fall off a cliff …

0

10

-10United States

-30

-20 Germany

Japan

-402005 2006 2007 2008 2009

8Source: Bank of Canada.

… and the first synchronized l b l i i 60 global recession in over 60 years.

World Economic GrowthWorld Economic Growth

6

7

Annual growth, per cent

IMF threshold for a global recession

3

4

5

1

2

3

-2

-1

0

9

1970 1975 1980 1985 1990 1995 2000 2005

Note: World real GDP growth on a purchasing-power parity basis.Source: International Monetary Fund World Economic Outlook, April 2009.

1 Fi i l i i d i1 Fi i l i i d i1. Financial crisis and recession1. Financial crisis and recession

2. Current recovery2. Current recovery

3. Looming challenges3. Looming challenges

10

A massive policy response …

1 Monetary policies1. Monetary policies- sometimes “unconventional”

2. Financial-market policiescertainl “ nfamiliar”- certainly “unfamiliar”

3 Fi l li i3. Fiscal policies- generally “timely, targeted, and temporary”

… helped to ensure our recovery …

115Components of Canadian GDP, 2008-2010

G t

105

110

Govt

Cons

95

100

Housing

GDP

90

95

Exports

80

85

Bus Inv

12

75-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7

Source: Bank of Canada.

2008Q3

… but it will be a while before things are back to “normal”things are back to “normal”.

Current output gap = 1.8%

Potential GDP

Actual GDP

The key risks to the recovery?

13

2008-Q3 2012-Q4Now

1 Fi i l i i d i1 Fi i l i i d i1. Financial crisis and recession1. Financial crisis and recession

2. Current recovery2. Current recovery

3. Looming challenges3. Looming challenges

14

1 Debt and Demographics1 Debt and Demographics1. Debt and Demographics 1. Debt and Demographics

2 Enhancing Productivity2 Enhancing Productivity2. Enhancing Productivity2. Enhancing Productivity

3 Cli t Ch3 Cli t Ch3. Climate Change3. Climate Change

15

Debt and DemographicsDebt and Demographics

16

Canada’s looming demographic “fiscalCanada’s looming demographic “fiscalCanada s looming demographic fiscal squeeze” :

Canada s looming demographic fiscal squeeze” :

- faster growth of expenditures- faster growth of expenditures- faster growth of expenditures- health care- elderly benefits

- faster growth of expenditures- health care- elderly benefitselderly benefitselderly benefits

- slower growth of tax base- slower growth of tax base

17

Declining fertility has been slowing population growth for decades growth for decades …

3 5Per cent

Historical Projection

2 5

3.0

3.5 Historical Projection

1 5

2.0

2.5

Current fertility rate is ~ 1.6.

0 5

1.0

1.5 rate is ~ 1.6.

0.0

0.5

1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

18

Source: Statistics Canada and Office of the Chief Actuary’s 23rd Actuarial Report on the Canada Pension Plan.

... which inevitably leads to aging of the population ...population ...

Share of age 15-64 in total population per centper cent

75Historical Projected

Entry of the baby boom generation into the labour market

Baby boomers gradually reaching retirement age

65

70into the labour market. retirement age.

60

65

55

66 72 78 84 90 96 02 08 4 20 26 32 38 44 50

19Source: Department of Finance Calculations based on Statistics Canada and Chief Actuary data

196

197

197

198

199

199

200

200

201

202

202

203

203

204

205

… and an increase in “age-related” spending.

Health spending and elderly benefits Health spending per capita

15Elderly Benefits

Health

25Thousands, Per capita % of GDP

9

12 Health

15

20

3

6

5

10

020

08

2010

2015

2020

2025

2030

2035

2040

2045

2050

0

0-14

15-2

4

25-3

4

35-4

4

45-5

4

55-6

4

65-7

4

75-8

4

85+

20

Source: Department of Finance Calculations

2 2 2 2 2 2 2 2 2 21 2 3 4 5 6 7

How to address this fiscal squeeze?How to address this fiscal squeeze?

1 Improve efficiency in health-care delivery?1 Improve efficiency in health-care delivery?1. Improve efficiency in health-care delivery?

2. Reduce growth of “other” spending?

1. Improve efficiency in health-care delivery?

2. Reduce growth of “other” spending?2. Reduce growth of other spending?

3. Increase taxes?

2. Reduce growth of other spending?

3. Increase taxes?

4. Increase borrowing? more debt4. Increase borrowing? more debt

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H bi i thi bl ?H bi i thi bl ?How big is this problem?How big is this problem?

Suppose we hold constant:“ th ” di h f GDP

Suppose we hold constant:“ th ” di h f GDP- “other” spending as share of GDP

t h f GDP

- “other” spending as share of GDP

t h f GDPWe need to avoid a return to the “debt - taxes as share of GDP- taxes as share of GDPWe need to avoid a return to the debt wall” of the mid 1990s!

Total public debt rises by ~ 50-60 t b t 2020 d 2050

Total public debt rises by ~ 50-60 t b t 2020 d 2050

22

ppts between 2020 and 2050.ppts between 2020 and 2050.

Enhancing ProductivityEnhancing ProductivityEnhancing ProductivityEnhancing Productivity

23

What drives “material” living standards?g

GDP/POP = (GDP/E) x (E/LF) x (LF/POP)

Per capita GDP = (labour productivity) x (employment rate) x (LF part. rate)

Past 40 years:

Next 30 years:

2424

Sources of growth, past and future:

Decomposition of per capita Real GDP Growth

2.0

2.5 GDP/POP of which: GDP/E E/LF LF/POP(percent)

Historical Projected

1.0

1.5

Historical Projected

0.0

0.5

-1.0

-0.5

Drag on future growth!

25Source: Finance Canada calculations consistent with January 2009 average private sector forecast

25

1971-2008 2009-2040

Small differences in growth rates matter a lot over the long term!over the long term!

Chained $2002 ThousandsReal GDP Per Capita (Dollars)

100

Chained $2002, Thousands

Assumes average productivity

Historic Projected

80growth of 2%

32%

40

60

A 1997 2007

20

71 77 83 89 95 01 07 13 19 25 31 37 43 49

Assumes 1997-2007 average productivity growth of 1.3%

We need to raise our productivity growth rate!

26

197

197

198

198

199

200

200

201

201

202

203

203

204

204

Source: Department of Finance Calculations

We need to raise our productivity growth rate!

But we have a worrying trend:

Canada’s Average Annual Productivity Growth (GDP per hour)Per cent

3.0

4

1 82

3

1.11.3

1.8

1

2

0

27

62-71 72-80 81-96 97-08

Notes: Total economy labour productivity measured using hours. Source: Center for the Study of Living Standards

Where does productivity growth come from?

ProductivityProductivity

Capital Investment Capital Investment and Technologyand Technology

R&D andR&D andR&D and R&D and InnovationInnovation

Education and Education and

28

TrainingTraining

Climate ChangeClimate Change

29

Projected Global GHG Emissions, 1990-2030

45Billions Mt of CO2

40 BAU projection

30

35

25

30 550ppmv CO2 stabilization*

201990 1995 2000 2005 2010 2015 2020 2025 2030

30

* 550 ppmv (parts per million volumes) of CO2e is the greenhouse gas concentration that is targeted to keep global temperatures from rising beyond 2C of preindustrial levels. Source: Department of Energy, Energy Information Agency, International Energy Outlook 2009 and IPCC

Predicted impacts from global warming:

1. Melting Greenland and Antarctic ice caps

2. Rising sea levels low island states

3. Creeping desertification

4. Falling agricultural productivity

31

Reducing GHG emissions is difficult!

f

g

1. Stock vs. flow.

2. Link between GHG emissions, energy use, , gy ,and GDP.

Challenge: Challenge:

How to reduce GHG emissions without d i li i d d ?reducing living standards?

A huge technological challenge.

32

g g g

World energy consumption and energy related CO emissions

170Index 1980 = 100

World energy consumption and energy-related CO2 emissions

150

160 World energy consumption

World CO2 emissions

120

130

140

100

110

120

80

90

1980 1985 1990 1995 2000 2005

33

1980 1985 1990 1995 2000 2005

Reducing GHG emissions will have Reducing GHG emissions will have significant economic effects:

1. Increase the costs of using carbon-based fuels.

2. Labour and capital will move between 2. Labour and capital will move between sectors and regions winners and losers.

3. Modest decline in growth rate of GDP.

34

A huge challenge of political will

Plenty of thorny policy issues:Plenty of thorny policy issues:Plenty of thorny policy issues:Plenty of thorny policy issues:

1. Carbon tax vs. “cap and trade”?

2. Regional and sectoral reallocations?

3 Public support for new technologies?3. Public support for new technologies?

4. The scope for international trading?4. The scope for international trading?

5. Tense international negotiations.

35

Canada’s Looming Economic Challenges

Debt and Debt and DemographicsDemographicsgg

Climate Climate ChangeChange

Enhancing Enhancing ProductivityProductivity

36

Thank you.Thank you.yy

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