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Bank of Canada unleashes billions to aid economy in what will likely be most severe recession ever

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April 15, 2020

The International Monetary Fund earlier this week observed that forecasting accurately during the coronavirus crisis is an extremely uncertain undertaking, but it still published an outlook that said the “Great Lockdown” will cause global GDP to contract by three per cent this year, the deepest since the Great Depression, followed by growth of 5.8 per cent in 2021.

The Bank of Canada faced the same near-impossible situation and decided not to bother. Instead, on April 15, it replaced its customary baseline projection with a “scenario analysis” of plausible outcomes that depend on how long it takes authorities to get COVID-19 outbreaks under control.

Bay Street economists will likely grumble about the central bank’s refusal to join their weekly scramble to update increasingly apocalyptic short-term forecasts, all of which are necessarily wobbly since they are premised on historical patterns that don’t include a once-in-a-lifetime event such as a global pandemic.

But the Bank of Canada’s focus is on the present, which contains all the information policy-makers need to realize that they have an epic fight on their hands. The central bank also unveiled a new set of emergency measures, including plans to create tens of billions of dollars in order to purchase provincial bonds and corporate debt. At the same time, it left the benchmark lending rate at 0.25 per cent, underlining the central bank’s reluctance to adopt negative interest rates.

“The Canadian economy is experiencing a significant and rapid contraction,” Governor Stephen Poloz said in a statement ahead of a conference call with reporters. “The shock is a global one, affecting all countries, but commodity-producing countries like Canada are being hit twice. In the very near term, policy-makers can do little more than cushion the blow.”

Canada’s central bank hasn’t closed its forecasting shop. On the contrary, the economic analysis division is probably working harder than ever, as staff incorporate new data sources to make better guesses on how the future might unfold.

For example, Poloz told reporters that China’s experience with re-opening its economy could hold information about how the future will unfold in Europe and North America. The Bank of Canada observed that road and subway traffic in China is back to pre-crisis levels during the week, but remains down on weekends, suggesting a hesitancy to return to life as normal.

The Bank of Canada was also willing to warn the public to brace for a terrible spring.

Gross domestic product in the second quarter could be between 15 per cent and 30 per cent lower than it was at the end of 2019, the central bank said in its latest quarterly economic report. At the same time, inflation could drop to zero, as spikes in prices for certain goods, including food, are outweighed by dirt-cheap gasoline and the disinflationary pressures that will come with broadly weaker demand.

“Despite a high level of uncertainty, these estimates suggest that the near-term downturn will be the sharpest on record,” the Bank of Canada said.

But that’s as precise as Poloz and his team of deputies decided to get. The governor said he wanted to avoid “false precision,” since there’s a risk the public could obsess over decimal-point estimates, while missing the disclaimers about how all forecasts right now are essentially wild guesses. “The bank doesn’t see itself as being in some sort of forecasting contest,” he told reporters. “It’s a tool of decision-making, as opposed to putting up numbers that may have very little analytical content.”

The central bank’s leaders are apparently comfortable doing their jobs without a precise outlook.

Poloz, overseeing one of his last policy meetings, pushed the central bank deeper into unfamiliar terrain. The Bank of Canada said it will start buying up to $50-billion worth of provincial debt in the “coming weeks,” along with $10 billon of investment-grade corporate bonds in the secondary market. Both are firsts, and both will expose the central bank to tricky political considerations, as provincial and corporate leaders could see such support efforts as an opportunity to delay difficult decisions.

But the persistent strain in credit markets trumps all such considerations for now. Provinces, particularly those that count on oil revenue, are especially at risk at a time when they will need to increase their borrowing to support their health-care systems.

“Liquidity, not moral hazard, is the watchword of the day,” said Kyle Hanniman, an assistant professor at Queen’s University in Kingston, Ont., who studies public debt. “Going forward, however, is another story. Even if programs are meant to be temporary, several provinces may come to be very dependent on federal support.”

First things first. The hundreds of billions of dollars that governments and the central bank are pushing into the economy could create the conditions for a relatively fast recovery. Many of the newly unemployed are in industries that are used to high rates of job turnover, suggesting those companies could be up and running fairly quickly once the lockdowns end.

“In this less severe and less persistent scenario, the decline in economic activity is abrupt and deep but relatively short-lived,” the Bank of Canada said.

Unfortunately, there is an equally plausible scenario in which the recession changes the nature of the economy, resulting in sluggish growth for a considerable period of time. Companies could go bankrupt and not come back, or employers could decide to carry on with reduced headcounts, thereby increasing unemployment. “These effects could cause structural damage to the economy that might not be undone for several years, if ever,” the central bank said.

It’s not the way Poloz anticipated ending his tenure as governor. “Today’s (Monetary Policy Report) will be my last,” he said. “I wish circumstances were more favourable.”

Financial Post

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