Public Information Notice No. 10/161

Public Information Notice: IMF Executive Board Concludes 2010 Article IV Consultation with Canada

December 22, 2010

On December 15, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Canada.¹

Background

Canada has weathered well the global recession, reflecting a strong economic and financial position at the onset of the crisis and a sizeable macro policy response. The large fiscal stimulus (totaling about 4 percent of one year’s GDP over two years) and prompt accommodation in monetary conditions strengthened domestic demand, and the economy posted robust growth rates in late 2009 and early 2010. Labor markets have been a particularly bright spot in the recovery, with Canada the only G-7 country (apart from Germany) that virtually recouped the loss in employment during the recession by mid-2010, and the first to record year-over-year increases in employment by the first quarter of 2010.

During the recovery, the Canadian current account deficit expanded on the back of brisk import growth, subdued exports to the United States—Canada’s main trading partner—and an appreciating Canadian dollar, given recovering commodity prices and capital flows. The financial system has avoided systemic pressures amid the global turbulence, thanks in good part to strong supervision and regulation. Financial markets have largely recovered from the turmoil and overall financial conditions remain accommodative.

However, the economic recovery is moderating and the outlook remains uncertain. In particular, domestic demand is slowing, amid stretched household balance sheets and a cooling housing market, following the introduction of tighter mortgage standards earlier this year in response to emerging risks. Net exports continue to be a drag on growth. Inflation has remained contained, with core inflation around the middle of the Bank of Canada’s control range. Looking ahead, risks are elevated and tilted to the downside with high household debt levels the main domestic risk, and a weaker U.S. outlook the largest external risk.

Macroeconomic policies are set to remain accommodative in the near term. In particular, monetary tightening has paused following rate increases between June and September that brought the target for the overnight rate to 1 percent and the phasing out of most of the extraordinary liquidity facilities. More recently, the Bank of Canada put further hikes on hold.

On fiscal policy, the authorities tabled a return to budgetary balance over the medium term with an ambitious and growth-friendly plan, while remaining committed to deliver the last year of stimulus. The near-term adjustment has been substantially smoothed by recent fiscal measures. Specifically, the extension by seven months of the deadline (to October 31, 2011) for infrastructure projects to be completed under the Economic Action Plan.

Canada’s financial system continues to display resilience, partly reflecting strong supervision and regulation. Financial soundness indicators are at strong levels. However, near-term risks have increased, including from stretched household balance sheets and U.S. exposures.

Executive Board Assessment

Executive Directors commended the authorities for the credible framework for macroeconomic policy, their strong policy response to the crisis and the resilient financial system, all of which have enabled Canada to exit the crisis on a strong footing. The recovery, forceful in the beginning, is now moderating and risks to the outlook have increased. To consolidate the gains achieved thus far, Directors encouraged the authorities to maintain their prudent and far-sighted policies, while further strengthening productivity and competitiveness.

Directors supported decisions by the Bank of Canada to put on hold further increases in its interest rates. The accommodative stance of monetary policy would support growth in the current economic environment. Inflation and inflation expectations remain well anchored within the Bank’s control range. Directors observed that monetary policy will have room for stimulus if needed.

Directors welcomed the authorities’ aim to return to fiscal balance over the medium term, which would put the net debt-to-GDP ratio on a downward trajectory. The authorities’ ambitious fiscal consolidation plans include growth-friendly measures to support Canada’s long-run economic potential, notably infrastructure spending and cuts in corporate income tax. In the event that the envisioned program spending restraint is not sufficient, additional measures would be needed.

Directors noted that in the longer run restraint in the growth of health-care spending would be essential. Left unchecked, such spending would put unsustainable pressure on public finances. They encouraged the authorities to increase communication about the attendant challenges to improve public awareness. Developing arrangements for provinces to share experiences in managing costs would also be helpful.

Directors welcomed the recent moves to reduce the near-term rise in employment insurance premia and to allow flexibility in deadlines for unfinished infrastructure projects. Directors agreed that these moves appropriately smoothed the up-front fiscal adjustment in light of the elevated risks to the outlook. They also noted that fiscal policy had ample room to respond if downside risks materialized.

Directors recognized that Canada’s financial stability arrangements are continuing to serve it well. Throughout the crisis, the financial system had maintained the ability to intermediate funds, and avoided systemic strains. Directors called for continued vigilance with regard to risks emanating from both domestic household debt and financial institutions’ exposures to the United States.

Directors observed that Canada is well positioned to adapt its financial regulatory framework to emerging international initiatives. The factors underlying Canada’s resilience, such as its well regulated mortgage market, have been key inputs to the international debate on financial regulatory reform. Further progress toward national securities regulation will be an essential enhancement in the financial regulatory framework.