Slow but steady

Why don't the media employ people who know how to interpret economic data any more?  A local news station in Toronto just introduced its report on Canada's August GDP data by describing the economy as "slowing".  Neither the headline number nor the details of the report support that conclusion in any way. 

According to Statistics Canada, real GDP grew 0.4 percent in August, compared to a decline of 0.1 percent in July.  It's true that this was slightly below StatsCan's preliminary estimate, but real GDP has grown 4.1 percent in the past twelve months. Fifteen of the 20 industrial sectors tracked by StatsCan posted higher output in the month, led by what the agency terms "client-facing services" such as accommodation and food services, as pandemic restrictions continued to ease.  The 7.0 percent month-to-month rise in accommodation and food services was the major driver behind the 0.6 percent gain posted by the entire services sector in the month.  

At first glance, the 0.1 percent fall in goods output in August looks worrisome. However, it turns out this was fully accounted for by a second consecutive sharp decline (5.7 percent) in agricultural output, which is almost entirely the result of drought conditions in the western Provinces. Manufacturing, which has been bedeviled by supply chain issues for several months, recorded a 0.5 percent gain in the month. 

StatsCan's preliminary estimate for GDP in September suggests almost no change from August, which leads it to project that real growth for Q3 as a whole was likely 0.5 percent.  (Actual data will be released on November 30). That annualizes to a 2 percent rate, identical to the  figure already reported for Q3 growth in the United States. With further removal of pandemic restrictions in Ontario and elsewhere, growth has very likely picked up again in October. Certainly the Bank of Canada sounded upbeat about the outlook earlier this week -- it's just a pity that nobody told CTV Toronto. 

"The upside risks are of greater concern"

The Bank of Canada kept its rate target unchanged at 0.25 percent today, as expected. However, the tone and wording of the rate announcement itself and of the accompanying Monetary Policy Report (MPR) were somewhat more hawkish than markets had anticipated. A series of rate hikes, likely starting before mid-2022, is now the probable outcome. 

Although the Bank's outlook for domestic growth is slightly lower than before, it is confident that the brief slowdown seen in the early summer is behind us. It describes the current growth picture as "robust", with strong employment gains and patchy labour shortages. It forecasts real GDP growth of 5 percent this year, slowing to around 4 percent in both 2022 and 2023. Growth will be broad based, supported by gains in consumption and investment at home and continuing growth in exports to the US. Based on persistent supply chain challenges, if warns the output gap is likely narrower than it had forecast as recently as July. 

The Bank claims that it had anticipated the recent rise in headline CPI, but admits that "the main forces pushing up prices – higher energy prices and pandemic-related supply bottlenecks – now appear to be stronger and more persistent than expected." It does not now expect inflation to return to the 2 percent target until late 2022, and notes that it will be "closely watching inflation expectations and labour costs to ensure that the temporary forces pushing up prices do not become embedded in ongoing inflation."

If we consider these growth and inflation projections together, it becomes clear that the Bank -- like other central banks around the world -- is operating in uncharted territory here. In more normal times, the rapid GDP growth and shrinking output gap the Bank is expecting would not be compatible with expectations of a decline in inflation. The hope of policymakers is that the unwinding of supply chain problems will both support strong growth and alleviate cost and price pressures, before expectations of persistently higher inflation become entrenched. 

This is by no means a sure thing, and the Bank acknowledges as much in the "Key messages" section of the MPR. While stating that it sees the risks to its base inflation forecast are "roughly balanced", it warns that "with inflation above the top of the Bank’s inflation-control range and expected to stay there for some time, the upside risks are of greater concern."

To clear the decks for the rate hikes that now look inevitable, the Bank has suspended its quantitative easing (QE)  programme and will keep its holdings of Canada bonds roughly constant. It still intends to provide "considerable monetary policy support" to the economy until current slack is absorbed, which  it now expects to happen "sometime in the middle quarters of 2022".  This supports the markets' growing conviction that rate hikes will start as soon as April, with the target rate conceivably reaching the dizzy heights of 1 percent by the end of 2022. 

Well this is kind of awkward

“When I use a word,” Humpty Dumpty said in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.” (Lewis Carroll, Through the Looking-glass)

Transitory (n): of brief duration; temporary. (Merriam-Webster)

Another month, another jump in that "transitory" inflation we keep hearing about. Statistics Canada reported this morning that Canada's consumer price index (CPI) rose 4.4 percent in the year to September. That's up from the 4.1 percent rise reported for August, and represents the fastest pace of consumer inflation since February 2003.

Gasoline prices continue to be a major driver of the headline figure, rising more than 30 percent from a year ago. If gasoline were excluded from the index, the annual rise in CPI would have been 3.5 percent. It's not just about gas prices, however. Every major component of the index rose in September, with significant gains reported for shelter costs (up 4.8 percent) and food, up 3.9 percent, led by a 9 percent rise in the price of meat. 

Two of the Bank of Canada's three preferred measures of core inflation ticked higher once again in September. The average increase of the three has now reached 2.7 percent, well below the headline number but moving steadily further away from the 2 percent target. The Bank's next Governing Council meeting and rate announcement are set for October 27; Governor Tiff Macklem has already admitted that the "transitory" rise in inflation has been sharper and more persistent than the Bank anticipated, and it will be interesting to see how the rhetoric changes next week.

Ever since the pandemic threw a wrench into monetary policy, the Bank of Canada has stressed its willingness to allow a period of above target inflation in order to sustain recovery in output. However, it has also stressed that it wishes to keep inflation expectations anchored at the 2 percent level, in order to maintain the long-term credibility of its policy approach. That credibility is coming under stress as inflation remains stubbornly high.

Financial markets are starting to bring forward the expected date for the start of a rate tightening cycle. My own former shop at TD Bank is fairly typical: it now sees a rate hike in July 2022, versus an earlier expectation of October, and it now sees a total of 75 basis points of tightening by the end of next year, bringing the Bank's target rate to 1.0 percent. It is evident that similar concerns are being felt outside the financial sector, The Bank of Canada's quarterly Business Outlook Survey, published at the start of this week, reported as follows:

Almost half of businesses now expect inflation to be above 3 percent over the next two years, with most anticipating it will be between 3 and 4 percent. Firms with inflation expectations above 3 percent frequently cited the following factors as supporting their expectations:

• supply chain disruptions
• fiscal and monetary policy stimulus
• recent increases in food and energy prices

In response to a special topic question, most firms anticipating inflation above 2 percent and about half of those with expectations above 3 percent said that the drivers of higher inflation are temporary.

The Bank may take some consolation from that final sentence, but it cannot ignore the messages it is receiving from financial and non-financial businesses alike. Next week's Governing Council meeting is likely to agree to reduce the scale of quantitative easing, and may offer a signal that once QE is wound up, actual rate hikes will not be long in coming. The credibility that the Bank has built up over the past two decades and more is at stake. 

With friends like these...

In 1969, Canadian Prime Minister Pierre Trudeau told the Washington Press Club that "Living next to you is in some ways like sleeping with an elephant. No matter how friendly and even-tempered is the beast, if I can call it that, one is affected by every twitch and grunt." Five decades on, those words still ring very true.

Joe Biden's very first act on assuming the presidency back in January was to cancel the Keystone pipeline project, which would have boosted exports of Canadian crude oil from Alberta to Gulf coast refineries.  Money that had been spent on construction of the pipeline went up in smoke, along with thousands of jobs. Nine months later, this egregious act of virtue signalling contrasts sharply with Biden's pleas for OPEC to boost oil production, as global crude prices head for $100/bbl. Canada is by far the largest supplier of US oil imports, but the lack of pipeline capacity makes it hard to boost those shipments when they're most needed. 

The centrepiece of Biden's domestic agenda is his so-called infrastructure spending plan -- "so-called" because the definition of infrastructure seems infinitely elastic. The size of the package is still in dispute -- $1.5 billion? $ 3.5 billion? Who knows?  But what is clear is a strong "buy American" theme running through the entire deal.  No surprise there -- protectionism runs deep in the US, particularly in the Democratic Party. This poses a particular threat to Canada, most notably the auto sector, as this article explains. It seems likely that many of these provisions will turn out to be in breach of the revised North American trade deal, but there's plenty of scope for damage to be done before that gets proved in court.

Then there's the border. The US and Canada closed "the longest undefended frontier in the world" to all but essential traffic back in March 2020, and that closure has been extended on a month-by-month basis ever since. (Travel by air has never been closed off). Canada reopened its border to fully vaccinated US travellers this summer, but the US kept Canadians (and Mexicans) out, even though Canada has done a much better job than the US in controlling the COVID pandemic. The land border will finally reopen for Canadian travellers on November 8, but the extended closure on the US side looks like a gratuitous slap in the face.

We started with virtue signalling and pipelines, so let's end there. The Line 5 pipeline carries Canadian oil and gas across Wisconsin and Michigan to supply Ontario and Quebec, as well as parts of Michigan, Pennsylvania and Ohio. It has been in operation since 1953 and has a good safety record. The pipeline crosses beneath the Mackinac Straits in northern Michigan. That state's Democratic governor, Gretchen Whitmer, has declared that portion of the pipeline is "a ticking timebomb" and wants it closed. 

This would cause serious harm not only to the two Canadian provinces, but also three US states, including Whitmer's own. The pipeline operator, Enbridge,  is resisting Whitmer's demand, backed by the Government of Canada and, it should be noted, by business interests and unions in the three affected states. The Biden administration has not responded to Canada's pleas for Federal intervention in the matter. It all seems set to wind up in court. In the meantime Enbridge's plan to build a tunnel to carry the pipeline safely under the lakebed is being reviewed, bizarrely as it seems, by the US Army Corps of Engineers. 

It's hard not to notice that Governor Whitmer's supposed concern for the purity of the waters of the Straits of Mackinac stands in sharp contrast with her state's failure to ensure safe drinking water for its citizens: just ask the people of Flint.  Really, with friends like these, Canada surely has no need of enemies. 

The Canadian Card

Canadian media are all a'flutter at the news that a Canadian economist is one of the winners of this year's Nobel Prize in economics.  In truth, it's not a "real" Nobel Prize, but then again the laureate in question hardly qualifies as a Canadian economist any more. David Card was born in Guelph, Ontario, and did his undergraduate work at Party Central (aka Queen's University, Kingston), but since graduating has plied his trade at a formidable list of US schools, including Princeton, Columbia, Chicago and Berkeley. He has US citizenship alongside the Canadian one he acquired at birth. Still, we mustn't be churlish, so sincere congratulations to Professor Card.

The research for which he has been honoured goes back in some cases to the 1990s, and falls into the category of applied econometrics known as "natural experiments".  Much econometrics involves the painstaking selection of randomized data in order to test hypotheses and if possible establish some sort of causal links between variables. Card's approach involves looking at situations in which the real world has in effect established quasi-random conditions, and then trying to tease out conclusions from that.

The work for which he is best known, carried out with a colleague who has since passed away,  involved an increase in the minimum wage in the state of New Jersey in the early 1990s. Conventional economic wisdom at the time suggested that such a move would result in reduced employment. However, by studying employment in the fast food sector in the western part of the state and comparing it to adjacent parts of Pennsylvania, where minimum wage was unchanged, Card was able to show that job losses did not in fact occur. Another similar study by Card showed that a sudden influx of Cuban refugees into south Florida in the Castro era dis not result in lower wages in that region. 

This is altogether very different from the economics that your humble blogger studied half a century ago. The curriculum was heavy on theory, with a substantial larding of mathematics, with linear algebra and difference equations part of the daily diet. Things are changing rapidly as the real world invades the halls of academe, and today's award is a recognition that researchers like Card and his fellow honorees are changing the way economists look at the world. 

Natural experiments are not perfect -- the results are perhaps best described as suggestive rather than definitive. What was true on the NJ/PA border in the 1990s is not necessarily true in other places at other times. Still, it's always helpful to be reminded that the handed-down wisdom of generations of economists, even about something as basic as the supply and demand for labour, should never be blindly accepted. 

Canada job market stays strong

Statistics Canada reported this morning that the economy added 157,000 jobs in September. This was the fourth successive monthly gain, and far exceeded the analysts' consensus expectation of a rise of 60,000. Today's data mean that employment has now returned to its pre-pandemic level, although as we shall see, there are some significant differences in the nature of that employment. The unemployment rate fell 0.2 percentage points to 6.9 percent, leaving it still well above the pre-pandemic level of 5.6 percent.

Almost 100,000 of the new jobs created in September were in the private sector. The service sector accounted for 142,000 new jobs, though there was a slightly surprising loss of jobs in the accommodation and food services category after several strong months. This likely reflects the winding-down of the peak tourist season. Both manufacturing and natural resources posted small employment gains.

There are a couple of surprising statistics that underline how the pandemic has changed the nature of employment in Canada.  Both public-sector and private sectors employment are at or above pre-pandmic levels, but self employment is fully 240,000 (or 8.4 percent) lower. One might have expected that the loss of conventional paid employment would drive more Canadians to try self-employment, but this is evidently not the case. One caveat here, however: as noted in this blog many times before, the self-employment data are notoriously volatile from month to month.

Here's another surprising nugget. StatsCan reports that the number of people employed in jobs not requiring post-secondary education was 287,000 lower than in September 2019. The agency's reason for choosing that month, rather than the last pre-pandemic month, is not clear. It has been evident all along that the pandemic was having a much more severe impact on lower-paid employees than those in higher wage and salary brackets, and this data allows us to quantify that. 

Where does this leave the Bank of Canada? The return of employment to its pre-pandemic level is an important milestone, though the fact that the unemployment rate remains elevated allows the Bank to argue that there is still slack in the labour market. Then again, Governor Tiff Macklem was forced to admit under questioning on Thursday that Canadian inflation was running hotter and might last longer than the Bank had expected (or hoped).  Markets are quite reasonably starting to think that rate hikes may be coming rather earlier in 2022 than previously seemed likely. 

The dumb ceiling

It is, I suppose, good news that a deal has been reached in Washington to extend the US "debt ceiling" and so eliminate, for now, the risk of a US debt default. It's only a temporary reprieve, however -- the ceiling is now set to expire in December, meaning that all this nonsense will start all over again in just a few weeks.

The debt ceiling has been in place since 1917, and only one country other than the US has such a thing: Denmark, of all places. The whole concept makes no sense, and in a way means that the US budget system is mathematically over-determined.

Think it through.  Congress gets to vote on the US budget each year -- spending and revenues. If spending exceeds revenue -- that is, there is a deficit -- the Treasury borrows to fund the gap. (Note to any MMT-loving readers: I know this isn't actually necessary, but it's how things work right now)!  The debt is simply the accumulated budget deficits resulting from those yearly spending and taxation decisions of the Congress. 

Setting a separate "ceiling" for that debt is unnecessary and illogical, and only serves to create the kind of shenanigans we have witnessed over the past few weeks. The Republicans are much more ruthless than the Democrats about using the ceiling for short-term political advantage, so you'd think the Dems might have used their wafer-thin majority in both Houses to abolish the stupid thing altogether, but here we are. One unfortunate aspect of today's deal: we've been robbed of the chance to hear the howls of anguish that would have come from the GOP if the much-mooted trillion-dollar platinum coin had made an appearance! 

A small setback

The headline number for Canada's GDP in July, released this morning by Statistics Canada, was surprising. Real GDP fell 0.1 percent in the month, leaving the economy about 2 percent smaller than it was when the pandemic began. StatsCan had already reported strong employment growth for the month, and July saw COVID restrictions eased in most Provinces, so it was reasonable to expect a more positive outcome. However, a look behind the headline is reassuring: it is highly unlikely that the decline in GDP recorded in the second quarter will be repeated in Q3. 

Of  twenty industrial sub-sectors covered by StatsCan's data, thirteen posted higher output in July. It is no surprise that the strongest gains were seen in sectors that had been hardest-hit by pandemic lockdowns earlier in the year. Accommodation and food services posted a second consecutive double-digit gain in the month, and the arts, recreation and entertainment sector was not far behind. These gains were offset by weakness in agriculture, largely the result of drought conditions in the Prairie provinces, as well as declines in utilities and manufactures. The fall in manufacturing output was concentrated in durable goods, suggesting that the global semi-conductor shortage again played a role. Retail trade was also slightly weaker in the month.

StatsCan has provided a preliminary estimate for real growth in August, indicating a 0.7 percent gain for the month. Further strength in accommodation and food and a rebound in manufacturing and retail trade are seen as the main contributors to growth partly offset by continuing drought-related weakness in agricultural output. Although some Provinces, notably Alberta and Saskatchewan, saw a worrying rise in COVID cases in September, there has been no reimposition of significant restrictions anywhere in the country, suggesting that the growth seen in August likely continued through the end of the third quarter.