The Bank of Canada doesn’t really know why the economy is so lousy right now

Governor Stephen Poloz was unusually candid about how much uncertainty there is in the economic data he and his colleagues use to make decisions

Bank of Canada Governor Stephen Poloz

Bank of Canada Governor Stephen Poloz speaking at a press conference, October 19, 2016. (Adrian Wyld/CP)

Rarely, if ever, has the Bank of Canada been so explicit about what went on at one of its policy meetings. In an extraordinary statement, Poloz told a press conference in Ottawa on October 19 that he; Senior Deputy Governor Carolyn Wilkins; and deputy governors Timothy Lane, Lawrence Schembri, Lynn Patterson, and Sylvain Leduc very nearly decided to cut the benchmark interest rate this week. “Given the downgrade to our outlook, Governing Council actively discussed the possibility of adding more monetary stimulus at this time, in order to speed up the return of the economy to full capacity,” Poloz said after the release of the central bank’s latest policy announcement.

The Bank of Canada is a conscientious objector when it comes to releasing minutes of its policy debates, even as most of its peers now do so. However, Poloz has turned the opening statement at his quarterly press conferences into something similar to minutes, using the opportunity to provide a touch of context and colour. There is no template, so the public must assume that whatever Poloz has chosen to reveal is there for a reason. In January 2015, when the central bank shocked investors by cutting the benchmark interest rates, policymakers were criticized for doing too little to prepare markets. If the Bank of Canada opts to cut borrowing costs in the months ahead, no one will be able to say they weren’t warned.

It has been a year since Prime Minister Justin Trudeau won the election, and the economy still sucks. The Bank of Canada’s new forecast will do little alter that narrative. The central bank now predicts gross domestic product will expand 1.1% this year, down from an estimate of 1.3% in July and little changed from 2015. That means Canada is stuck in one of the weakest phases of economic growth on record. In 2017, the Bank of Canada sees an acceleration to 2%, compared with an earlier estimate of 2.2%. Policy makers now say it will take until the middle of 2018 before Canada’s economy is generating output at a level that would put upward pressure on inflation, “materially later” than was previously expected.

What happened? A better question is, “What didn’t happen?” The Bank of Canada’s struggle to explain disappointing non-energy exports is well documented. (I have written about it recently here, here, and here.) Policymakers still are working on it. The currency is worth about 20% less against the U.S. dollar than it was in 2014, and money never has been cheaper. Non-energy exports have climbed out of the massive pit left by the Great Recession, but they are nowhere near the level the central bank’s models suggest they should be. Poloz said they can explain about half the miss through the combination of weaker U.S. demand and the general slowing of global trade since the financial crisis.

The other half? The central bank has no idea. It offered some suggestions, saying executives and business owners have said they are afraid to expand because electricity in Canada is too expensive, big energy projects are too slow to get off the ground, the future of present and future trade agreements is iffy, and the U.S. election is too frightening. As Poloz said in his press conference, these sorts of things are hard to model. They may also be excuses. Regardless, the central bank has grown tired of being disappointed. In October, it decided that some of the trade gains that it had been waiting for are simply never going to come.

Policy makers slashed the contribution that exports will make to growth in 2017 to 0.8 percentage point of the overall gain, from an estimate of 1.1 percentage points in July. That won’t be enough to offset the GDP-shrinking effects of imports, which subtract from growth because they pull money out of the country. Bottom line: at a time when the Bank of Canada was counting on exports to become an engine of economic growth, trade likely will be a net negative, according to the October 2016 Monetary Policy Report. “The growth rate (of non-energy exports) persistently was less than what we thought should happen and it’s gradually building up to something that we have to acknowledge, and we have to say, ‘Either it comes back someday after firm creation kicks in more strongly’ or something,” Poloz said. “For now, we are going to assume it is permanent.”

Time for some nuance. The Bank of Canada’s latest communication sounds depressing. It is important to note that nothing like a recession is on the horizon. Poloz’s overall assessment of the economy is that things are “OK.” The governor emphasized that the central bank’s confidence in its outlook is unusually shaky. “The data have been less than clear about as to which economic forces are dominant,” the governor said at his press conference. In the policy statement, the central bank said it was comfortable that it was on track to meet its inflation target, “albeit in a context of heightened uncertainty.” Conditions could worsen, but it is just as likely they could improve. The value of the Canadian dollar was little changed, suggesting investors saw little reason to panic.

Probably the main reason the Bank of Canada decided against cutting interest rates was Trudeau. The biggest driver of economic growth next year will be from household consumption, which policy makers reckon will get a boost from the federal government’s tax cuts and its decision to augment monthly child benefits. And the other main source of economic growth over the next couple of years will come from government spending, led by the federal government’s infrastructure program. Trudeau’s spending promises never were going to provide much kick in the first 12 months—there wasn’t enough time. After reading the Bank of Canada’s latest economic assessment, it is sobering to think what we would be facing if a party intent on balancing the budget had won the election.