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
1. The Long Road to Respect: From Zero to Hero
2. Fiscal Consolidation Canadian Style
3. Banking and Macro-prudential Regulation:
The Canadian Experience
4. 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 After
the Crisis”
Dramatic Improvements
in Fiscal Policy
Source: T. Macklem (2010), “Fiscal Policy During and After
the Crisis”
Thinking About the Long-term
Source: T. Macklem (2010), “Fiscal Policy During and After
the Crisis”
Fiscal Returns I
2005
Fiscal Returns II
2005
Fiscal Consolidation & Growth:
The Canadian Experience
Real GDP growth - CANADA
8
Percent change (%)
6
4
2
0
-2
-4
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Source: Own calculations from CANSIM II
Canada’ Growth VS US Economic Growth
Canada LESS US Real GDP Growth (%)
3
2
1
0
-1
-2
-3
-4
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
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)
Select Credit measures for Canada, 2000-2011
70
Percent of GDP
60
50
40
30
20
10
2000
2002
Total Consumer credit
2004
2006
Total mortgage credit
2008
2010
Short-term busines s credit
10,000
9,000
8,000
7,000
$/Price
6,000
5,000
4,000
3,000
2,000
1,000
2000
2002
2004
2006
real s hort-term bus cr
real total mtge cr
2008
2010
real total cons cr
real total other bus cr
14
12
Percent change
10
8
6
4
2
0
2000
2002
total cons cr
2004
2006
total mtge cr
2008
2010
total other bus cr
Source: Author’s
calculations
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?
CANADA
6
5
4
4
3
Percent
Percent
2
2
0
1
-2
0
-4
-1
2000
2002
2004
realized real GDP
2006
2008
real GDP growth forecasts
2010
2000
2002
2004
realized CPI inflation
2006
2008
2010
Inflation forecast
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
AUSTRALIA
CANADA
4.8
4.70
4.65
4.6
4.5
4.4
4.65
4.60
log of price level
log of price level
4.7
log of price level
EURO AREA
4.70
4.55
4.50
4.40
1996
1998
2000
2002
CPI
2.5% drift in price level
2004
2006
2008
4.55
4.50
4.45
4.3
4.60
4.45
1996
1998
2000
2% drift in price level
2002
CPI
JAPAN
2004
2006
2008
1996
1998
2000
2% drift in price level
NEW ZEALAND
4.90
2002
CPI
2004
2006
2008
2% drift in price level
SWEDEN
4.76
4.80
4.72
4.85
4.75
4.75
4.70
4.64
log of price level
log of price level
log of price level
4.68
4.80
4.60
4.56
4.52
4.70
4.65
4.60
4.48
4.65
4.55
4.44
4.60
4.40
1996
1998
2000
2002
CPI
1% drfit in price level
2004
2006
2008
4.50
1996
1998
2% drift in price level
No price level drif t
2000
SWITZERLAND
2004
2006
2008
1996
UNITED KINGDOM
4.70
4.70
4.65
4.65
log of price level
4.65
4.60
log of price level
4.80
4.70
4.60
4.55
4.50
4.45
4.55
2002
CPI
2% drift in price level
2004
2006
1% drift in price level
2008
2006
2008
2% drift in price level
4.60
4.55
4.50
4.40
4.35
2000
2004
4.45
4.40
4.50
2002
UNITED STATES
4.75
1998
2000
CPI
1% drift in price level
4.75
1996
1998
2.5% drift in price level
4.85
4.75
log of price level
2002
CPI
2% drift in price level
4.35
1996
1998
2000
2002
CPI
2% drift in price level
2004
2006
2.5% drift in price level
2008
1996
1998
2000
2002
CPI
2% drfit in price level
2004
2006
2008
2.5% drift in price level
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
Source: BoC MPR July 2011
36
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!