Why Poloz Just Got Bullish on How Fast Canada Can Grow

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(Bloomberg) -- We can do better.

That’s the prime reason why Bank of Canada Governor Stephen Poloz elected to hold off on raising rates in April, saying the Canadian economy has more room to grow than previously expected.

The central bank upped its estimate for potential growth -- how fast an economy at full capacity can expand without generating too much inflation -- to 1.8 percent over the next two years from a projection of 1.6 percent in the January report. It’s a substantial upgrade from its previous review that had potential growth at 1.4 and 1.5 percent in 2018 and 2019, respectively.

These new estimates formally put numbers to the growth narrative that Poloz highlighted in recent speeches: The Canadian economy is in a “sweet spot” where new investment can increase the nation’s growth capacity and bring people off the sidelines and into the workforce without generating too much inflation.

This is “a phase worth nurturing,” he said in Kingston, Ontario. “We actually have an obligation to test this framework and find where those limits actually are, because that creates benefits for everyone.”

Changes of tenths of a percentage point -- as well as revisions to historical data -- make a big difference. A higher top speed for growth means there’s more economic slack than previously envisaged, informing the central bank’s decision to keep rates unchanged at this juncture.

Underlying Poloz’s bullish assessment is the belief that Canadian businesses need to expand, and will elect to do so domestically. In turn, the investment spending increases labor productivity as more equipment boosts worker output per hour.

The monetary policy report notes that three-quarters of industries have a capacity utilization rate within 5 percentage points of their post-2003 peak. The business outlook survey, meanwhile, indicates that sales expectations have firmed. Taken together, this implies that there’s a real need for investment to meet higher demand.

The chief concern is that protectionism, which remains the central bank’s top risk to the outlook, coupled with the U.S. tax overhaul means businesses will choose to expand capacity outside of Canada. A “wide range of outcomes” are still possible for the North American Free Trade Agreement, per the report, which did not acknowledge recent reported progress in talks between Canada, Mexico, and the U.S.

“Differences in fiscal and regulatory policies could have a more negative impact on investment, and thus productivity, than is currently expected,” the Governing Council wrote.

In the near term, revisions to Canada’s capital stock and spending loom large in the bank’s upgrade to labor productivity. However, that same data “may be revised down later this year,” according to the report, citing a recent underwhelming Statistics Canada survey of investment intentions for this year.

There’s also the chance that the decline in investment is structural and linked to population aging. Older people tend to have a lower demand for durable goods and a higher need for services in the labor-intensive, low-productivity segments of the economy like health care. Digitalization of the economy, meanwhile, works the other way, potentially raising potential growth.

Indeed, imports of machinery and equipment -- a leading indicator of productivity-enhancing investment -- have softened in the first two months of 2018.

A separate discussion paper published by central bank staffers in October 2017 concluded that even under an alternative scenario in which the potential level of growth was ultimately 1 percent higher than forecast by 2020, the effects on inflation would be “small” and “therefore does not affect the stance of monetary policy.”

©2018 Bloomberg L.P.

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