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Canadian Policy Responses to the Global Financial Crisis and Economic Recession Lawrence Schembri International Department May 7 2009 For presentation at the Canada Day conference, Rimini Centre for Economic Analysis, Rimini, Italy The views expressed in this presentation reflect those of the author and not the Bank of Canada Why is the Canadian experience interesting & worthy of attention? 1. Canada entered the crisis in much better shape 2. Canada adopted the right policies at the right time. 3. Canada will recover faster, despite being in a notso-good neighbourhood Bottom line: 1. Important lessons can be learned from Canada 2. The crisis will instigate useful reforms to domestic and international policy 2007: Going into the Crisis Government debt to GDP ratio was falling Annual Debt to GDP % 180 180 160 160 140 140 120 120 100 100 80 80 60 60 40 40 1995 1996 Source: OECD 1997 1998 1999 Japan 2000 2001 Germany 2002 2003 Italy 2004 2005 Canada 2006 USA 2007 2008 2009 Taxes were declining Annual Government Tax Revenue/GDP 46 % 46 44 44 42 42 40 40 38 38 36 36 34 34 32 32 30 30 28 28 26 26 24 24 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: DataStream Japan Germany Italy USA Canada Inflation was stable & inflation expectations were well anchored Annual Canadian Inflation % 4 4 3.5 3.5 3 3 2.5 2.5 2 2 1.5 1.5 1 1 0.5 1995 1996 1997 Source: StatsCan, Consensus Economics 0.5 1998 1999 2000 Core Inflation 2001 2002 2003 Headline Inflation 2004 2005 2006 2007 Consensus Forecast 2008 Commodity prices were rising and the loonie was strong Annual Commodity Prices and Effective Canadian Dollar Index 1995=100 220 220 200 200 180 180 160 160 140 140 120 120 100 100 80 80 60 60 40 40 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Bank of Canada CERI BCPI Consumer debt levels were also rising, but not too fast Annual Household Debt/GDP and Debt Service Ratios % 160 % 15 14 140 13 12 120 11 100 10 9 80 8 60 7 6 1995 1996 1997 Source: StatsCan, Federal Reserve 40 1998 1999 2000 2001 2002 Canadian HH DSR (LHS) Canadian HH Debt/GDP (RHS) 2003 2004 2005 2006 2007 US HH DSR (LHS) US HH Debt/GDP (RHS) 2008 House prices were rising, but not bubbling Annual House Price Indices 2000=100 250 250 230 200 210 190 150 170 150 100 130 110 50 90 70 0 1995 1996 1997 1998 Source: National Bank, S&P, Bank of Spain, Global Insight 50 1999 2000 Ireland 2001 2002 Spain 2003 Canada 2004 2005 USA 2006 2007 2008 Bank leverage ratios stayed calm Annual Leverage Ratios - Major Banks 40 40 35 35 30 30 25 25 20 20 15 15 10 10 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: Bloomberg Euro Area US UK Canada Crisis Chronology 1. 2. 3. 4. Financial Crisis began: August 2007 U.S. Recession began: December 2007 Lehman Bros Collapse: September 2008 Synchronized Global Recession: 2008Q4 and 2009Q1 Global banks lost money Annual Bank Writedowns US$ Blns 450 450 400 400 350 350 300 300 250 250 200 200 150 150 100 100 50 50 0 0 Canada Source: Bloomberg US UK 2007 Italy 2008 2009 Germany Japan Note: 2009 Figures are YTD Deleveraging took hold and economies contracted Quarterly GDP Growth Rates % Q/Q AAR 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 -2 -2 -4 -4 -6 -6 -8 -8 -10 -10 -12 -12 -14 -14 07q3 07q4 08q1 Source: Bank of Canada, StatsCan, Bank Calculations (China) USA UK 08q2 Euro Area 08q3 Japan 08q4 Canada 09q1 China Canadian Policy Responses • Financial Sector • Fiscal Policy • Monetary Policy Financial Sector Policy 1. Liquidity provision (Bank of Canada) 2. Bank liability guarantees (Government of Canada) – “Lenders Assurance Facility” 3. Support for credit markets (Government of Canada) 4. NOT NEEDED - Removal of toxic assets / bank capital injections Liquidity Facilities • The Bank of Canada has introduced several new facilities to provide liquidity to capital market participants: 1. Swaps of high quality, but less liquid assets for short-term government bonds 2. Collateralised loans • Key innovations: Wider sets of participants and acceptable collateral Credit Market Support 1. CDN $125B Insured Mortgage Purchase Program 2. Additional CDN $13B for Export Development Canada, Business Development Bank of Canada, and several other Crown corporations to facilitate trade and business credit 3. CDN $12B Canadian Secured Credit Facility, to support vehicle leasing through purchases of Asset Backed Securities Daily Spreads between 3-month Interbank Offered Rates and Overnight Index Swap Rates* bps 400 400 350 350 300 300 250 250 200 200 150 150 100 100 50 50 0 Jul07 0 Sep07 Nov07 Jan08 Mar08 May08 * Canada: CDOR, US and UK: LIBOR, and EU: EURIBOR Source: Bloomberg; last observation end of day 1 May 2009 Jul08 Canada Sep08 Nov08 Jan09 Mar09 US Europe UK Canadian Fiscal Stimulus 1. Approximately CDN $40B or 2.5% of GDP 2. 60% will be infrastructure spending 3. 55% will be spend in 2009 and 2010 4. CDN $8.0B in permanent personal and corporate tax cuts 5. Leverage infrastructure/community spending with the provinces to reach CDN $50B Monetary Policy Actions 1. Aggressive interest rate cuts: 425 basis points in 16 months to a target overnight rate of 0.25% 2. Unconventional policy measures • • • Conditional statement: hold rates at this level until 2010Q2 conditional on inflation outlook Term Purchase and Resale Agreements (6-12 months in duration) Framework for credit and quantitative easing Monthly Canadian Policy Rates and Inflation % 5 7 4.5 6 4 5 3.5 3 4 2.5 3 2 1.5 2 1 1 0.5 0 Jan 04 0 Jul 04 Jan 05 Jul 05 Jan 06 Target Rate Source: StatsCan, Bank of Canada Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 Prime Lending Rate Core Inflation Jan 09 Daily Monetary Authority Policy Rates 6 % 6 5 5 4 4 3 3 2 2 1 1 0 2005 2006 Source: National Monetary Authorities 0 2007 Canada USA 2008 Euro Area UK 2009 Aside: Credit and Quantitative Easing • Quantitative easing -- outright purchase of government or private sector assets with central bank reserves • Credit easing -- outright purchase of private sector assets with the sale of other central bank assets (sterilized purchases) or in conjunction with quantitative easing and the creation of central bank reserves (unsterilized purchases) Annex on “Framework for Conducting Monetary Policy at Low Interest Rates” Figure 1: Financing and Type of Asset Purchases Outlook Quarterly Canadian GDP Growth Forecast % U.S. demand composition should be more favourable to Canadian exports Annualized Quarterly Growth % Projection for Total CPI Inflation Lessons for Domestic Policy • Macroprudential oversight of financial system • Mitigate procyclicality in banking regulation • National securities regulator • Monetary policy at low interest rates • Monetary policy should not ignore financial stability concerns Lessons for International Policy 1. Financial Stability Board - Bigger and Tougher • Common standards/rules for financial sector • College of supervisors of global financial institutions (peer review process) • Crisis resolution procedures for ``too big to fail`` 2. IMF – More resources and More Candid • + US$500B; New instruments: Flexible Credit Line • Better external and internal governance • Address financial stability; early warning system Extra Slides Commodity prices were rising and the loonie was strong Annual Energy Prices and Canadian/US Exchange Rate 1995=100 1.1 520 480 440 1 400 360 0.9 320 280 240 0.8 200 160 0.7 120 80 0.6 40 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Bank of Canada Exchange Rate (LHS) Energy Prices (RHS) Daily Spreads between 1-month Interbank Offered Rates and Overnight Index Swap Rates* 350 bps 350 300 300 250 250 200 200 150 150 100 100 50 50 0 Jul07 0 Sep07 Nov07 Jan08 Mar08 May08 * Canada: CDOR, US and UK: LIBOR, and EU: EURIBOR Source: Bloomberg; last observation end of day 1 May 2009 Jul08 Canada Sep08 Nov08 Jan09 Mar09 US Europe UK Daily Canadian Corporate Bond Index Option-Adjusted Spreads 550 bps 550 500 500 450 450 400 400 350 350 300 300 250 250 200 200 150 150 100 100 50 50 0 0 Jan07 Mar07 May07 Jul07 Sep07 Nov07 Jan08 Mar08 May08 Jul08 Sep08 Nov08 Jan09 Mar09 Source: Merrill Lynch A BBB AA Last observation end of day 1 May 2009 Weekly Par Value Outstanding for BoC Liquidity Facilities C$ (blns) 40 40 35 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 S O N D J F M A * Outstanding values as of Thursday each week; final value is for 30 April, 2009 Source: Bank of Canada Term PRA Term Loan Facility & Term PRA for Private Sector Instruments Projection for Global Economic Growth Share of real global GDPa (per cent) 2008 2009 2010 2011 United States 22 1.1 (1.2) -2.4 (-1.7) 1.2 (2.6) 2.9 European Union 20 0.7 (0.9) -3.6 (-1.0) -0.2 (2.1) 1.8 Japan 7 -0.7 (0) -6.2 (-1.7) 0.1 (2.0) 2.5 China and Asian NIEsc 14 7.1 (7.5) 3.5 (5.6) 6.0 (6.9) 7.3 Others 37 4.9 (5.0) 1.0 (2.7) 3.0 (4.3) 4.0 World 100 3.2 (3.4) -0.8 (1.1) 2.2 (3.7) 3.7 a. Projected growth (per cent)b GDP shares are based on IMF estimates of the purchasing-power-parity (PPP) valuation of country GDPs for 2006. Source: IMF, WEO Update, October 2008. b. Numbers in parentheses are projections from the January 2009 Monetary Policy Report Update. c. NIEs are newly industrialized economies. These include Hong Kong (Special Administrative Region), South Korea, Taiwan (Province of China), and Singapore. Source: Bank of Canada Bank of Canada Liquidity Facilities Introduced Since 2007Q4 Weekly Peak Amount Amount Announced Offered Outstanding** Term PRA 12 Dec 07 $2 to 12 billion $37 billion Term Loan Facility (TLF) 12 Nov 08 $2 billion $4.175 billion Eligible Securities Approved Counterparties SLF eligible: GOC securities, NHA-MBS, CMBs, other government guaranteed securities, provincial bonds, BAs, CP, ABCP, BDNs, corporate bonds, UST Primary dealers and direct participants in the Large Value Transfer System Non-mortgage loan portfolios Direct participants in the Large Value Transfer System Term PRA for Private Sector Money Market* 14 Oct 08 $1 billion $25 million BAs, BDNs, CP, ABCP Term PRA for Private Sector Instruments 23 Feb 09 Minimum $1 billion N/A BAs, BDNs, CP, ABCP and corporate bonds * This facility was replaced by the Term PRA for Private Sector Instruments on 16 March, 2009 ** In par-value terms Primary dealers and federally / provincially regulated market participants who demonstrate significant activity in private money markets Federally / provincially regulated market participants who demonstrate significant activity in private bond and/or money markets Canadian Fiscal Stimulus