US close to edge on recession – can have ripple effects in Canada

Saturday, August 26th, 2006

ECONOMY I Canada would need lower taxes and interest rates, bank economist says

Eric Beauchesne

OTTAWA — The odds of a U.S. recession have increased dramatically, a Canadian bank economist is warning.

And if the U.S. does see a prolonged period of negative growth, it would require a shift in policies by governments and the Bank of Canada to keep the Canadian economy from slipping into a recession, too, the National Bank of Canada’s chief economist said Friday.

That would require income tax cuts by the federal and other levels of government and interest rate cuts by the Bank of Canada, Clement Gignac said in an interview after the bank announced the odds of a U.S. recession have nearly doubled to 40 per cent from the 25 per cent it estimated in the spring.

Its announcement came in the wake of further evidence this past week the U.S. housing market is going from boom to bust, including a much steeper-than-expected drop in home sales and a surge in the inventory of unsold homes on the market.

“We have long held the view that a bursting of the U.S. housing bubble would be bearish for the U.S. economy,” the bank said in a statement issued at week’s end.

It’s only a matter of time before the surge in inventories leads to a nationwide decline in home prices that will erode personal wealth at a time when energy bills and debt obligations have hit record highs and that in turn will force consumers to cut spending and rebuild their savings, it said.

“Against this backdrop, we have decided to raise the odds of a U.S. hard landing,” it said.

That means a recession of two straight quarters “or worse” of shrinking economic activity, Gignac noted. The odds are still a bit greater the U.S. will avoid a recession, but “we are close to the edge.”

Patricia Croft, chief economist with Phillips, Hager and North Investment Management Ltd., agreed the slump in the U.S. housing market is increasing the risks of a U.S. recession, which would sink Canada’s economy as well.

“It’s the single biggest risk to the U.S. economy and . . . we haven’t seen the bottom yet,” she said. “There may be a bit of a lag but if the U.S. goes down we’re going down with them.”

Gignac agreed that normally a U.S. recession would drag Canada’s economy down with it, noting one-third of Canadian economic activity is from trade, more than 80 per cent of which is with the U.S.

But Canada might be able to escape with merely a slowdown rather than an outright recession, he added.

Despite some hot spots, Canada’s housing market never really overheated, so there is no Canadian housing bubble to burst, Gignac said. And the Western provinces, especially, are booming, which will also help buoy the national economy.

But to limit the damage of a U.S. recession to the Canadian economy, he said the federal governments and the Bank of Canada will have to shift to a “much more aggressive expansionist policy.”

And they are in a position to do that, he said, noting that unlike other industrial countries, governments here are in a budget surplus position and can afford to cut income taxes.

“We are in the best position in five decades to deal with a U.S. recession . . . if the monetary and fiscal authorities react promptly,” Gignac said.

In fact, Canada avoided being dragged down by the last U.S. recession at the start of this decade thanks in large part to the economic stimulus from the former Liberal government’s $100-billion five-year tax cut package.

However, in its first budget earlier this year the Conservative government, while cutting the GST, raised income taxes.

Some other economists, meanwhile, remain optimistic about the outlook for both the U.S. and Canadian economies.

“We’re just basically moving from a high gear to a low gear, and then it will be onward and upward again,” said Scotiabank economist Aron Gampel.

© The Vancouver Sun 2006


Comments are closed.