Canada's Schembri Says Expansion Repairing Damage to Capacity

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(Bloomberg) -- Bank of Canada Deputy Governor Lawrence Schembri said the current economic expansion is helping to repair damage caused by the last recession on the nation’s productive capacity.

Schembri, in a speech focused on aggregate supply issues, said that while the nation’s overall scope to produce goods and services, and generate non-inflationary growth, is driven by factors such as demographics and productivity, the 2008-2009 recession was so severe that it continues to have an impact on potential output. Those effects are beginning to be reversed now that the economy has run up against constraints, he said.

“The Great Recession was a once-in-a-lifetime shock to aggregate demand that, because of its severity, also affected aggregate supply,” said Schembri, according to a prepared text of his speech in Ottawa. “With the economy now operating close to potential, solid demand growth is spawning business investment, firm entry and improved labor-market conditions -- all of which are helping to repair that damage.”

The idea that Canada’s economy can prolong its current expansion without fueling inflation has become a central narrative for the Bank of Canada. Governor Stephen Poloz has been claiming Canadas is at a “sweet spot” of the business cycle, where growing demand is actually generating new capacity as companies invest to meet sales, and that he has an “obligation” to nurture this process with stimulative borrowing costs.

“As noted in recent policy statements, we are closely monitoring this expansion in economic capacity,” Schembri said.

A key component of the central bank’s last monetary policy report in April was the sharp upward revision to its assessment of how much the economy can grow without fueling inflation, a signal policy makers are more at ease with capacity constraints.

“Our 2018 reassessment revised the profile for potential higher than it was in the 2017 reassessment, both in terms of its level and growth rate,” Schembri said. “That means that, in the near term, we have a bit more room than we thought to support demand without sparking undue inflationary pressures.”

Other Highlights

  • The trend over the past decade across developed economies for falling potential output growth is a major challenge for central banks, since it implies lower global real interest rates
  • Lower neutral rates reduce room for central banks to respond to shocks
  • Lower potential growth also limits governments in their ability to implement countercyclical fiscal policy since it slows revenue
  • Three policy areas that can boost potential are education, increased immigration and trade liberalization, Schembri says

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