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Lessons from Canada from the International Financial Crisis of 2007-?. Pierre L. Siklos BSIA & WLU Viessmann European Research Centre A Lecture at the Joint Vienna Institute – April 2012. Outline of Talk. The Long Road to Respect: From Zero to Hero Fiscal Consolidation Canadian Style - PowerPoint PPT Presentation
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Lessons from Canada from the International Financial Crisis of 2007-?
Pierre L. SiklosBSIA & WLU
Viessmann European Research CentreA Lecture at the Joint Vienna Institute – April 2012
Outline of Talk
1. The Long Road to Respect: From Zero to Hero2. Fiscal Consolidation Canadian Style3. Banking and Macro-prudential Regulation:
The Canadian Experience4. Monetary Policy: Credibility and Effectiveness
The Long Road to Respect:From Zero to Hero
• In January 2005, the Wall Street Journal called CANADA “an honorary member of the third world”. The Canadian dollar was referred to as the “northern peso”.
• What are they saying now?
The Long Road to Respect:From Zero to Hero
• “Canada has emerged as a favoured destination for investors seeking refuge from the turmoil sweeping the euro zone and the continuing uncertainty over the U.S. fiscal position.” WSJ
• “Part of the allure is Canada's sterling fiscal position.” WSJ• “Canada’s ratings are supported by its institutional and structural
strengths, underpinned by effective policy response and a history of macroeconomic and social stability. Canada’s macro prudential approach to policymaking has allowed years of economic growth and stable prices in Canada.” Fitch
Fiscal Consolidation Canadian Style
• 1995, as it turns out, is a pivotal year in Canada’s fiscal policy
• It begins with Paul Martin’s budget speech with a crystal clear message: – “The time to reduce deficits is when the economy is
growing. So now is the time.”– “Short-term targets are the surest way to get to zero.”
Fiscal Consolidation Canadian Style
Source: http://www.fin.gc.ca/budget95/speech/speech.pdf
Fiscal Consolidation Canadian Style
Source: http://www.fin.gc.ca/budget95/speech/speech.pdf
Fiscal Consolidation Canadian Style
• An extraordinary committee of ‘cuts’• Cuts in spending NOT tax increases• Transparency and accountability not ‘sugar
coating’– Equivalent to a ‘fiscal rule’
Canada’s Net Debt, 1970-1995
Source: T. Macklem (2010), “Fiscal Policy During and Afterthe Crisis”
Dramatic Improvementsin Fiscal Policy
Source: T. Macklem (2010), “Fiscal Policy During and Afterthe Crisis”
Thinking About the Long-term
Source: T. Macklem (2010), “Fiscal Policy During and Afterthe Crisis”
Fiscal Returns I
2005
Fiscal Returns II
2005
Fiscal Consolidation & Growth: The Canadian Experience
-4
-2
0
2
4
6
8
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Real GDP growth - CANADAPe
rcen
t cha
nge
(%)
Source: Own calculations from CANSIM II
Canada’ Growth VS US Economic Growth
-4
-3
-2
-1
0
1
2
3
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Cana
da L
ESS
US
Real
GD
P G
row
th (%
)
Source: Own calculations from CANSIM II
Better than the Rest?
Source: http://www.theglobeandmail.com/news/politics/budget/infographic-your-2012-federal-budget-explained/article2384109/
Learning the Lesson 2012 Style?
Source: http://www.theglobeandmail.com/news/politics/budget/infographic-your-2012-federal-budget-explained/article2384109/
Banking and Macro-prudential Regulation: The Canadian Experience
• Canada’s financial system is regulated by 4 main ‘actors’– Bank of Canada
• Provided liquidity assistance during the crisis
– OSFI (Office of the Superintendent of Financial Institutions)• Regulatory arbitrage is kept to a minimum by effective leverage oversight
– CDIC (Canada Deposit Insurance Corp.)– FCAC (Financial Consumer Agency of Canada)
• Bottom Line? Both entity and activity regulations are in place• There exists a formal mechanism in place for the regulators to
communicate & exchange information
Banking and Macro-prudential Regulation: The Canadian Experience
• Canada’s Banks did not require an injection of public capital during the crisis– Very few sub-prime mortgages and none insurable after 2008– Canadian banks rely less on repos and securitization– Canada’s banks are expected to EXCEED Basel II Tier I and capital-asset
ratios (approx. 10/13%; Basel II is 4/8%)– Canada’s banks have conservative risk appetites
Why Conservative Risk Appetite?
• Insurance is mandatory if loan-to-value ratio is > 80% (largest insurer is CMHC, a Federal agency)
• CMHC does not insure sub-prime mortgages• Securitization is largely limited to meet
liquidity needs and NOT risk transfer
Canadian Banks’ ROR
Spreads and the Financial Crisis
Liquidity & the Crisis
Canada’s Financial System: Some Challenges
• Poorly structured non-bank asset-backed commercial paper– “Because liquidity for this paper was guaranteed only in the event of a "general market
disruption," liquidity providers – most of whom are international banks – declined to step in as this paper has come due.” (Dodge Sept 2007)
• Household Debt levels are rising quickly as MP continues to be relatively ‘easy’• Counter-cyclical buffers are necessary• Off-balance sheet items should be included in capital ratio calculations• Regulation is shared with the Provinces & there are too many securities regulators
(in each Province) – Although a ‘passport’ system is in place (except Ontario)
10
20
30
40
50
60
70
2000 2002 2004 2006 2008 2010
Total Consumer credit Total mortgage credit Short-term business credit
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
2000 2002 2004 2006 2008 2010
real short-term bus cr real total cons crreal total mtge cr real total other bus cr
0
2
4
6
8
10
12
14
2000 2002 2004 2006 2008 2010
total cons cr total mtge cr total other bus cr
Percen
t of GD
P$/P
rice
Percen
t chang
e
Select Credit measures for Canada, 2000-2011
Source: Author’scalculations
Canada’s Financial System: Some Challenges
• Poorly structured non-bank asset-backed commercial paper– “Because liquidity for this paper was guaranteed only in the event of a "general market
disruption," liquidity providers – most of whom are international banks – declined to step in as this paper has come due.” (Dodge Sept 2007)
• Household Debt levels are rising quickly as MP continues to be relatively ‘easy’• Counter-cyclical buffers are necessary• Off-balance sheet items should be included in capital ratio calculations• Regulation is shared with the Provinces & there are too many securities regulators
(in each Province) – Although a ‘passport’ system is in place (except Ontario)
Monetary Policy: Credibility and Effectiveness
• IT regime has remained in place with relatively few changes since the early 1990s– The 2% target was renewed in the Fall of 2011 for another 5 years– Inflation and inflation expectations have remained stable
• A concern for financial system stability may cloud the issues (Tinbergen’s principle)
• Where to next?– Price level targeting?– More transparency?
-4
-2
0
2
4
6
2000 2002 2004 2006 2008 2010
realized real GDP real GDP growth forecasts
Perc
ent
CANADA
-1
0
1
2
3
4
5
2000 2002 2004 2006 2008 2010
realized CPI inflation Inflation forecast
Perc
ent
Source: Author’s calculations
Monetary Policy: Credibility and Effectiveness
• IT regime has remained in place with relatively few changes since the early 1990s– The 2% target was renewed in the Fall of 2011 for another 5 years– Inflation and inflation expectations have remained stable
• A concern for financial system stability may cloud the issues (Tinbergen’s principle)
• Where to next?– Price level targeting?– More transparency? Success and Failure
4.3
4.4
4.5
4.6
4.7
4.8
1996 1998 2000 2002 2004 2006 2008
CPI 2% drift in price level2.5% drift in price level
log o
f pric
e le
vel
AUSTRALIA
4.40
4.45
4.50
4.55
4.60
4.65
4.70
1996 1998 2000 2002 2004 2006 2008
CPI 2% drift in price level
log o
f pric
e le
vel
CANADA
4.45
4.50
4.55
4.60
4.65
4.70
1996 1998 2000 2002 2004 2006 2008
CPI 2% drift in price level
log o
f pric
e le
vel
EURO AREA
4.60
4.65
4.70
4.75
4.80
4.85
4.90
1996 1998 2000 2002 2004 2006 2008
CPI 2% drift in price level1% drfit in price level No price level drif t
log o
f pric
e le
vel
JAPAN
4.40
4.44
4.48
4.52
4.56
4.60
4.64
4.68
4.72
4.76
1996 1998 2000 2002 2004 2006 2008
CPI 2.5% drift in price level2% drift in price level
log o
f pric
e le
vel
NEW ZEALAND
4.50
4.55
4.60
4.65
4.70
4.75
4.80
1996 1998 2000 2002 2004 2006 2008
CPI 2% drift in price level1% drift in price level
log o
f pric
e le
vel
SWEDEN
4.50
4.55
4.60
4.65
4.70
4.75
4.80
4.85
1996 1998 2000 2002 2004 2006 2008
CPI 1% drift in price level2% drift in price level
log o
f pric
e le
vel
SWITZERLAND
4.35
4.40
4.45
4.50
4.55
4.60
4.65
4.70
4.75
1996 1998 2000 2002 2004 2006 2008
CPI 2.5% drift in price level2% drift in price level
log o
f pric
e le
vel
UNITED K INGDOM
4.35
4.40
4.45
4.50
4.55
4.60
4.65
4.70
4.75
1996 1998 2000 2002 2004 2006 2008
CPI 2.5% drift in price level2% drfit in price level
log o
f pric
e le
vel
UNITED STATES
Source: Author’s calculations
Monetary Policy: Credibility and Effectiveness
• IT regime has remained in place with relatively few changes since the early 1990s– The 2% target was renewed in the Fall of 2011 for another 5 years– Inflation and inflation expectations have remained stable
• A concern for financial system stability may cloud the issues (Tinbergen’s principle)
• Where to next?– Price level targeting?– More transparency? Success and Failure
Inflation Targeting: The Communications Challenge“Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target. The Bank will continue to provide guidance in its scheduled interest rate announcements as long as the overnight rate is at the effective lower bound.” BOC MP Report, April 2009, p.2
33
IT and ‘Headwinds’ VS ‘Tailwinds’ I
36Source: BoC MPR July 2011
The Message?• Figure 2-A and Figure 2-B plot the hypothetical responses of inflation, the output gap and the target
overnight rate to a negative foreign demand shock. • Figure 2-A illustrates the case of a simple Taylor-type rule where the overnight rate mechanically responds
to deviations of current inflation from the target. In this scenario, inflation returns to target, output returns to its potential and the overnight rate returns to its 2 A Taylor-type rule specifies policy in terms of current inflation and the estimated current level of the output gap. long-run level, all at the same time, after the effects of the headwinds have fully dissipated.
• Figure 2-B illustrates the more desirable case where the central bank takes better account of the expected headwinds from the sustained decline in foreign demand. The central bank leans more heavily into the headwinds by maintaining interest rates further below their long-run level, which more fully offsets the effects of weaker foreign demand on the domestic economy. This allows inflation to return more quickly to the target (and stay there) and output to potential, before the policy rate returns to its long-run level, as illustrated.
The End!
