Riding the Commodity Price Roller-Coaster Presentation to FLAR in Cartagena, Colombia 10 July 2018 John Murray Former Deputy Governor, Bank of Canada
Outline Why Canada is different from other industrial economies Challenges posed by large swings in commodity prices Six factors working in Canada s favour How well has the system worked in practice? Six things Canada could do better Conclusion good and bad lessons to draw from Canada
Canada Is Different Canada has a very open economy The only G7 economy with a higher export/gdp ratio is Germany Canada is unlike all other major industrial economies in two respects: (1) It is a major commodity producer (2) It relies importantly on exports of commodities It is therefore more vulnerable to large swings in commodity prices In many ways Canada is more like an emerging market economy
Chart 1: Exports as a Percentage of GDP in Major Industrial Countries Plus Australia Annual data % 50 40 30 20 10 United States Japan Australia United Kingdom Canada France Italy Germany 0 Sources: OECD via Haver Analytics and Bank of Canada calculations Last observation: 2017
Chart 2: Commodities as a Percentage of GDP in Major Industrial Countries Plus Mexico Nominal share of commodity production to total GDP % 20 16 12 8 4 Sources: Haver Analytics and Bank of Canada calculations Canada Germany Mexico United Kingdom USA 0 Last observation: 2017; Germany, 2015
Chart 3: Commodity Exports in Selected Countries Nominal share of commodity exports to total exports % 50 40 30 20 10 Canada Germany Mexico United Kingdom USA 0 Sources: UN Comtrade and Bank of Canada calculations Last observation: 2017
Chart 4: Volatility of Commodity Prices versus the Consumer Price Index Index: 2002 = 100, monthly data Index 500 400 300 200 100 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017 Energy Agriculture Metals and minerals Consumer price index 0 Source: Statistics Canada and Bank of Canada calculations Last observation: Commodities, May 2018; CPI, April 2018
Six Factors Working in Canada s Favour Six features of the Canadian economy help it adjust to shocks: (1) Diversification across regions, industrial sectors, commodities (2) Flexible exchange rate as an important shock absorber (3) Inflation target to anchor price expectations (4) Fiscal framework with large automatic stabilizers (5) Increasingly mobile labour force (6) Well-developed capital market for hedging and financing
Chart 5: Canada's Diversified Industrial Base Nominal share of commodity production to total GDP, annual data % 10 8 6 4 2 Paper manufacturing Wood product manufacturing Fabricated metal product manufacturing Primary metal manufacturing Agriculture, forestry, fishing and hunting Other commodities Mining, quarrying, and oil and gas extraction 0 Sources: Statistics Canada and Bank of Canada calculations Last observation: 2017
New Brunswick Prince Edward Island Nunavut Nova Scotia British Columbia Manitoba Northwest Territories Quebec Alberta Ontario Newfoundland and Labrador Saskatchewan Yukon Chart 6: Uneven Distribution of Commodities Across Provinces Commodities as a percentage of GDP in provinces and territories, annual data % 40 30 20 10 0 Sources: Statistics Canada and Bank of Canada calculations Last observation: 2017
Chart 7: Nominal Commodity Shares by Major Group Nominal weights of major commodity groups used for the Bank of Canada commodity price index, annual data % 100 90 80 70 60 50 40 30 20 10 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 0 Energy Agriculture Metals and minerals Forestry Fisheries Source: Bank of Canada Last observation: 2018
How Well Has the System Worked Practice? Strong evidence that things have been working largely as expected: (1) Exchange rate movements closely tied to commodity prices (2) Fiscal transfers acting as a timely and effective buffer (3) Large inter-regional and inter-sectoral labour movements (4) Timely and effective monetary policy responses There are limits, however, to how much insulation can be expected Canadian and US economies are tightly bound Why similar macro-economic cycles might be a sign of success
Chart 8: Tight Relationship Between Swings in the Canadian Dollar and Commodity Prices Monthly data USD/CAD 1.2 Index 900 1.1 1.0 0.9 0.8 0.7 800 700 600 500 400 300 0.6 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 200 Exchange rate (left scale) Bank of Canada commodity price index (index: 1972 = 100, right scale) Sources: Statistics Canada and Bank of Canada Last observation: May 2018
Chart 9: Tight Relationship Between Actual and Predicted Values of the Exchange Rate Monthly data USD/CAD 1.1 1.0 0.9 0.8 0.7 0.6 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 0.5 Actual exchange rate Exchange rate predicted by the Issa-Lafrance-Murray equation Sources: Statistics Canada and Bank of Canada Last observation: May 2018
Newfoundland and Labrador Prince Edward Island Nova Scotia New Brunswick Quebec Ontario Manitoba Saskatchewan Alberta British Columbia Yukon (TFF) Northwest Territories (TFF) Nunavut (TFF) Chart 10: Equalization Transfers Across Provinces and Territories Fiscal years data $ millions 12000 10000 8000 6000 4000 2000 0 Source: Department of Finance Canada 2013-14 2017-18
Chart 11: Tight Relationship Between Canada's GDP and U.S. GDP Year-over-year percentage change, quarterly data % 9 6 3 0-3 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017-6 Canada United States Sources: Statistics Canada, Haver Analytics, and Bank of Canada calculations Last observation: 2018Q1
Six Ways Performance Could Be Improved What could be done to make things better? (1) Removing inter-provincial barriers to trade (2) Removing inter-provincial barriers to labour mobility (3) Making discretionary fiscal policy less pro-cyclical (4) Saving for a rainy day and sovereign wealth funds (5) Correcting design flaws in unemployment insurance (6) Improving the Equalization Payment system
Conclusion - Good and Bad Lessons Canadian economy responds well to commodity price shocks It has several structural advantages and macro policies that help A flexible exchange rate and an inflation target are definite pluses Nevertheless, things are far from perfect Many constraints to improved performance are policy related Political considerations are an overriding and complicating factor Looking ahead to new challenges: environmental concerns, climate change and stranded assets