Canada soothes on world economy, but ready to act

Canada's top economic policymakers see a raft of risks for a fragile yet still growing global economy, but are ready to intervene in case of major world turmoil. In testimony to a parliamentary committee on Friday, Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty both highlighted the risks posed by Europe's stubborn debt crisis and the slow US recovery from recession.
But neither forecast a recession in either area, although Carney admitted that Canada's economy might contract in the second quarter. "Our expectation is that growth is going to be lower," Carney said of the situation in Europe and the United States. "I would not say that our base-case view has been revised so that there would not be growth in those economies, that is not the case."
Canada weathered the global recession better than most countries, helped by a robust financial sector and more than a decade of federal budget surpluses, as well as by tax cuts introduced before world economies began to slow and then by a package of government stimulus spending. That package is now coming to an end, and Flaherty dismissed the idea of large-scale renewed spending as a panacea.
"More spending now, in the current environment - that actually is the problem in Europe," he said. "Too much spending, accumulated deficits, its exactly what we should not do if we want to maintain the fundamental fiscal health that we have in Canada." But if the world economy slowed dramatically, Canada would "do what was needed" to protect jobs and to shelter its own economy. "We would act in a pragmatic way as we have done successfully previously and recently," he said.
In his testimony, Carney said the United States faces its weakest economic recovery since the Great Depression, after a recession that turned out to be deeper than first thought. Problems surrounding Europe's sovereign debt crisis have intensified, and that could continue to have an impact on jumpy global markets, which have yo-yoed higher and lower in recent tension-filled weeks.
"Acute fiscal and financial strains in Europe have triggered a generalised retrenchment from risk-taking and could yet prompt more severe dislocations in global funding markets," Carney said. Up to a month or so ago, when economies around the world started showing increasing signs of stress, most analysts had expected the Bank of Canada would raise interest rates again later this year or early next, in line with its promise to keep inflation around its 2 percent target.
But Carney made it clear that a rate rise would depend on what the economy did. "Since the crisis erupted, the bank has demonstrated its flexibility and nimbleness in the conduct of monetary policy," he said. "As the Canadian recovery has progressed, we have emphasised that we would be prudent with respect to the possible withdrawal of any degree of monetary stimulus."
Canadian inflation has remained above that 2 percent target for the last 10 months, although it eased to 2.7 percent in July, from 3.1 percent in June, matching market expectations. Carney said a promise by the US Federal Reserve to keep rates low for another two years was positive for Canada in that it was providing additional stimulus to the US economy in the form of steady rates all the way along the yield curve.
But it would not by itself affect Canada's own interest rate policy. "What matters for the Bank of Canada is what happens in the US economy," Carney said. "We do not outsource monetary policy to the Federal Reserve... The policy stance of the Federal Reserve is not the policy stance of the Bank of Canada."
It is rare for parliamentary committees to hear testimony of this nature during the summer break. The opposition New Democrats had called for the hearings as financial markets swooned during what is traditionally a quiet summer season, partly on fears that the world was heading back into recession.