Taking bets...

I am now taking bets for the first quarter of 2009's gdp growth rate. My money is on the outlier, Merrill, with a 9% contraction.

April 23rd, the numbers are in: -7.3%!!! far from the Bank's -4.8% and only just under the worst 'outlier' at 9%.

Alberta's heritage fund ($15B).... no comment

Managing expectations

One of the principle conclusions of economic thinking regarding monetary policy during the last quarter of the 20th century involves the binding role of expectations on Central Banks. As the old argument went, central banks could always spur extra growth by printing more money. This works while people are deceived into believing they have more wealth, and spend it, but runs afoul as soon as they catch on. Worse, from the point of a central banker, if people are aware of this process, if it is part of how the form their expectations for the future course of the economy they live in, printing money will have no effect but to raise prices.

Several research articles thus brought us the notion that the best a central bank can do is control inflation, and can only do so effectively if it is credibly committed to following such a rule (i.e. 'I won't try to cheat you in the future by printing money). This notion of credibility is closely intertwined with the call to "manage expectations," "expectations" here being those of consumers and firms and "manage", well, that's the tricky part.

The theory, in essence, suggests Central Banks should commit to one rule of behavior and stick to it. Managing expectations is no more involved than that. But if you work for a central bank, that's not too sexy. You are essentially an automaton, not a "big player", a mover and shaker of the economy. So in the last years of the twentieth century central bankers began to think they could manage expectations in the broadest sense, that is expectations over the entire economic reality we live in. The culmination of this process within central banks is the belief that their single opinions can shape the direction of entire economies.

Over the last month the Bank of Canada has shown that is suffers from this delusion of grandeur. In December the Bank told us the recession would be deep and prolonged. This week the announcement is of a short recession. So short, in fact, all will be back to normal by 2010. While this goes smack against the forecasts of more venerable institutions (let alone its own statements of a few weeks ago), it confirms a growing sense that the bank is not only poor at forecasting, it is vulnerable to political interference, increasingly singing the government's tune (Central Bank independence is a sine qua non condition for credibility).

The risk for all of us is the eventual loss of all credibility of future statements by the Bank of Canada, unraveling the entire process by which the bank has any hope of achieve in intended mission of controlling inflation.

Macroeconomic policy when we need it

The process of searching for a job myself taking up all my attention, posts have been and will be scarce until it comes to some conclusion. In the mean time, here is an excellent post on macroeconomic policy and recessions.

Stephen Harper and Canada's subrime market

A wonderful article in today's Globe and Mail put the pieces together and explains how the Conservatives' 2006 budget opened the door to the issuance of high risk mortgages in Canada.

"The new rules encouraged the entry of such U.S. players as American International Group – the world's largest insurance company – and Triad Guarantee Inc. of Winston-Salem, N.C. Former Triad chief executive officer Mark Tonnesen, who spearheaded his company's aborted push into Canada, said the proliferation of high-risk mortgages could have been mitigated if Ottawa had been more watchful. “There was a lack of regulation around the expansion of increased risk,” he said."

According to the same article, "new mortgage borrowers signed up for an estimated $56-billion of risky 40-year mortgages, more than half of the total new mortgages approved by banks, trust companies and other lenders during that time".

A big surprise? No, not really

It made the headlines of the National and every media outlet out there, the Bank of Canada reduced it's overnight lending rate by 0.75% to 1.5%, a 'deep cut' for some commentators. Will it have an effect? not really. Is it a sign of worse to come? I fear it may. But first here is why this cut does not come as a surprise and why, if the Bank is going to cut rates in the future, it may have only one bullet left in its charger.

The latest big economic news was released last Friday: Canada lost 71 000 jobs and the US about half a million. Proportional to the size of our economies, Canada's numbers are much worse than what happened down South. The recession could no longer be denied and with Parliament out the Bank was left alone to provide any stimulus to the economy.

Overnight lending concerns only a fraction day to day costs banks handle. With our banks already in a weak position from other investments not doing so well, even if our banking system were competitive you would not see the full reduction passed on to consumers (to a certain extent it would irresponsible for banks to do so). My more fundamental concern, and this is why I fear there is worse to come, is that the problem we face is not the cost of credit but rather its nonexistence. Banks simply are not lending (ask any business owner, they'll tell you). In that situation, the traditional tool of lowering rates to nudge up investment isn't going to get us anywhere. The Bank of Canada is in a difficult position, the interest rate is so low there remains very little room for anything but one, final, drastic cut to the overnight rate (if your going to end up at 0%, might as well go out with a bang). After that we face to possibility of being in a liquidity trap.

The solution? Helicopter money. I'm not joking. Milton Friedman's idea, not mine. And it's a sensible one. If banks aren't lending, then the central bank should drop huge wads of cash from helicopters into the hands of businesses and consumers to get them to spend again. Now, implementing an actual helicopter drop is out of the question but it does tell us what policies we should want our government to pursue: spend, spend, spend, bypassing the banking system.

Most of the pain at the moment is concentrated in Southern Ontario, Canada's manufacturing belt, but expect the end of winter and early spring to lead with piles of canceled tar sands, refinery and related projects in Alberta and Saskatchewan. World demand for oil will slump much further in 2009 (see this article in the Financial Times) and the days of even $40 barrels we be far behind us (another reason the environmental movement has got it's focus all wrong).

Deconstructing Ottawa

Quick reaction to the Throne Speech. The weakening of the federal government will shift into a higher gear this year as the Conservatives will slash chunks away from pensions, benefits and salaries of the civil service. Crise économique oblige, I hear Harper saying.....