This is Your Economy on Stimulus

My post on this past Monday’s Gross Domestic Product (GDP) release emphasized the disconnect between profits and investment in the corporate sector. As Andrew commented on that post, the public sector’s contribution to the recovery is also noteworthy.

That point seems especially relevant in the wake of a federal budget devoted to continuing previously announced stimulus. The right-wing critique from outside the Conservative Party seemed to be that the budget should have stopped or reduced announced fiscal stimulus because Canada’s economy is already recovering thanks to the magic of the market and/or monetary policy.

Output has indeed recovered somewhat since bottoming out in the second quarter of 2009. How much of that recovery was driven by fiscal stimulus? There are a couple of methodological challenges in breaking down GDP to address this question.

First, nationwide output is obviously difficult to count. Even in the unadjusted, current-dollar figures, Statistics Canada acknowledges a “statistical discrepancy” between total GDP and the sum of its components.

Second, the official figures are seasonally-adjusted at annual rates in chained 2002 dollars. The separate seasonal adjustment of total GDP and of each GDP component creates a further difference (in any given quarter) between the total and the sum of components.

Such discrepancies of a few billion dollars are tiny in the context of a $1.3-trillion economy. However, they loom larger when comparing particular quarters. Total GDP grew by $18.8 billion between the second and fourth quarters, but adding up the components suggests growth of only $13.4 billion (unless my arithmetic is wrong.)

Canada’s GDP (seasonally-adjusted in billions of 2002 dollars)

 
Economic growth has been net of a substantial deterioration in Canada’s trade balance. As components of real GDP, imports have recovered much faster than exports. (Canada’s trade deficit has narrowed slightly in current dollars due to higher prices for commodity exports, but the volume of exports has expanded far less than the volume of imports.)

Given the exchange rate’s sharp rise since the second quarter, it is relatively cheaper for Canadians to buy imports and relatively more expensive for the world to buy Canadian exports. I would count the consequent $22.5-billion drag on GDP as a major strike against Canadian monetary policy. In any case, the recovery to date reflects roughly $40 billion of additional domestic spending.

Consumer expenditures accounted for more than one-third of this increase. Monetary policy has helped make consumer credit available again while fiscal policy has promoted spending and put more money in consumers’ pockets (e.g. the home-renovation tax credit and extended Employment Insurance). However, it is difficult to conclude that either monetary or fiscal policy is mainly responsible for resurgent consumption.

Government expenditures on goods, services and investment (excluding cash transfers) accounted for about one-third of the increase in domestic spending. The public sector has punched far above its weight. While direct government spending amounted to just under 40% of consumer spending in the second quarter, it has provided nearly 90% as much growth since then ($12.8 billion versus $14.4 billion).

Public infrastructure has played an especially important role. Government investment amounted to below 4% of GDP in the second quarter, but has propelled at least 12% of subsequent domestic growth. Expanded government purchases and investments are entirely attributable to fiscal stimulus.

Business investment accounted for less than one-third of the domestic-spending increase. Most additional business investment has gone into residential structures. Corporate Canada is actually investing slightly less in non-residential structures and equipment. The small remaining increase in business investment reflects smaller withdrawals from inventories.

I am inclined to give low interest rates full credit for the current housing boom. The rest of the measured increase in business investment may just reflect inventories running low. However, even if one attributed the entire increase in business investment to low interest rates, monetary policy still contributed appreciably less than fiscal policy to Canada’s recovery ($8.7 billion versus $12.8 billion).

Of course, the internationally-coordinated response of monetary policy was critical in stopping the economic free fall that began in late 2008. Indeed, I advocated that the Bank of Canada cut its target interest rate to zero months before it did so.

But despite the importance of monetary policy, it is ridiculous to argue that fiscal policy should stand down because monetary policy is on the job. They are complements rather than substitutes and fiscal policy has driven significantly more of Canada’s recovery to date.