A Federal Budget Designed for the Times

The Economic Action Plan of 2009

A Federal Budget Designed for the Times

The Economic Action Plan of 2009

Christopher RaganMcGill University

and Department of Finance

May 7, 2009

2

Outline of Talk

1. Global Economic Context, January 2009

2. Canadian Economic Context, January 2009

3. Three Key Budget Themes

4. Final Bits

-- no politics

3

Global Economic Context,

January 2009

4

-20

-15

-10

-5

0

5

10

15

20

2001Q1

2002Q1

2003Q1

2004Q1

2005Q1

2006Q1

2007Q1

2008Q1

A collapse in the U.S. housing market …A collapse in the U.S. housing market …

U.S. Housing Starts and Months Supply of Existing HomesU.S. Housing Starts and Months Supply of Existing Homes

U.S. S&P/Case-Shiller Home Price Index U.S. S&P/Case-Shiller Home Price Index

per cent, year over year

400

800

1,200

1,600

2,000

2,400

Jan2001

Jan2002

Jan2003

Jan2004

Jan2005

Jan2006

Jan2007

Jan2008

Jan2009

3

4

5

6

7

8

9

10

11

12

thousands,at annual rates

level, months supply atcurrent sales rate

Housing Starts (left scale)

Months supply of existing homes (right scale)

5

… led to losses in U.S. banks and huge write-downs worldwide.… led to losses in U.S. banks and huge write-downs worldwide.

U.S. Write-downs and LossesU.S. Write-downs and Losses

0102030405060708090

100110

Citi

gro

up

Ban

k o

f A

me

ric

a

JP

Mo

rga

n C

ha

se

Go

ldm

an

Sa

ch

s

Mo

rga

n S

tan

ley

Me

rrill

Ly

nc

h

Le

hm

an

Bro

the

rs

Billions, USD

Source: Bloomberg. April 17, 2009

Global Write-downs and Losses Exceed $1 trillionGlobal Write-downs and Losses Exceed $1 trillion

0

200

400

600

800

1000

1200

1400

World Canada U.S. Europe Asia

Billions, USD

6

What was initially viewed largely as a problem of liquidity…

…became a problem of systemic stability after the fall of Lehman Brothers on September 15.

7

Equity markets contributed to the global financial carnage.Equity markets contributed to the global financial carnage.

Source: Bloomberg. Up to and including April 24, 2009.

IMF’s Estimates of Financial Sector Potential Writedowns (2007-2010)

0

500

1000

1500

2000

2500

3000

3500

4000

4500

World U.S. Europe* Japan

Billions, USD

-70

-60

-50

-40

-30

-20

-10

0

Canada(S&P/TSX)

U.S. (S&P500)

U.K. (FTSE100)

EMU (DJEuro

STOXX)

Total

Banks

World Equity Markets

% change since January 1, 2007

*Europe includes Euro area and the U.K.Source: IMF’s Global Financial Stability Report, April 2009.

8

Credit spreads increased sharply…Credit spreads increased sharply…

Credit Spreads

Notes: These spreads are a measure of banks’ funding costs relative to a risk-free rate and are a gauge of financial market stress and banks’ financing pressures. The rate on the overnight-indexed swap (OIS) is used as a proxy for expected overnight rates. LIBOR is the London Interbank Offered Rate. CDOR is the Canadian Dealer Offered Rate.

Daily data up to and including April 24, 2009.Source: Bloomberg.

basis points

-40

0

40

80

120

160

200

240

280

320

360

400

Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09

Canada (CDOR - OIS)

U.S. (LIBOR - OIS)

Euro area (LIBOR - OIS)

9

Credit growth

Source: Bank of Canada.

Year-over-year percentage change

0

2

4

6

8

10

12

14

2005 2006 2007 2008 2009

Household Credit Business Credit

… and (with a lag) affected credit growth.… and (with a lag) affected credit growth.

historical averages:1992-present

10

Central banks were aggressive and also “creative” in their actions.Central banks were aggressive and also “creative” in their actions.

• Capital Injections• Troubled Assets Relief Program• Direct investments in financial institutions, e.g.

Barclays, ING, AIG, Fortis

• Guaranteeing the liabilities of financial institutions

• U.S., Ireland, U.K.

• Nationalization • Fannie Mae, Freddie Mac, Icelandic banks

• Purchase of “toxic assets” • Public-Private Investment Fund, Asset Protection

Scheme (UK)

• Supporting financial markets • Commercial Paper Funding Facility, Term Asset-

Backed Securities Loan Facility, Canadian Secured Credit Facility

Policy Interest Rates

per cent

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Sep2007

Dec2007

Mar2008

Jun2008

Sep2008

Dec2008

Mar2009

U.S. Federal Reserve

Bank of Canada

European Central BankBank of England

Sources: Bank of Canada, U.S. Federal Reserve, European Central Bank and Bank of England.

Global actions to support the financial sector

11

Can we really speak of the financial sector separately from the “real” economy?

Economists were soon reminded of the importance of credit to production and employment.

Financial markets and the “real” economy?Financial markets and the “real” economy?

12

Source: Bank of Canada.

Year-over-year percentage change

Industrial production in major economies slowed sharply ... and then fell off a cliff!Industrial production in major economies slowed sharply ... and then fell off a cliff!

Industrial Production

-40

-30

-20

-10

0

10

2005 2006 2007 2008 2009

United States

Germany

Japan

13

We were faced with the first synchronized global recession in over sixty years …We were faced with the first synchronized global recession in over sixty years …

World Economic Growth

-2

-1

0

1

2

3

4

5

6

7

1970 1975 1980 1985 1990 1995 2000 2005

per cent

Forecast

Actual

Note: World real GDP growth on a purchasing-power parity basis.Source: International Monetary Fund World Economic Outlook, April 2009.

IMF’s threshold for a global recession

14

… with considerable uncertainty about the global economic outlook.… with considerable uncertainty about the global economic outlook.

Mean of Private-Sector Forecasts for 2009 Real GDP Growth

per cent

Source: Blue Chip Economic Indicators - January 2008 to April 2009.

Date of forecast

6.5

7.5

8.5

9.5

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09

-6

-5

-4

-3

-2

-1

0

1

2

3

China (left)

Canada (right)

U.S. (right)

Eurozone (right)

Japan (right)

per cent

15

The knowledge that recessions triggered by financial stress tend to be longer and deeper … The knowledge that recessions triggered by financial stress tend to be longer and deeper …

Source: IMF World Economic Outlook, April 2009.

Duration and output loss

0 1 2 3 4 5 6

All recessions

Financial crises

Highly synchronizedrecessions

Duration (quarters)

Output loss (%)

16

… led to an internationally coordinated response.… led to an internationally coordinated response.

• G-20 Commitments:

• Restoring global growth by coordinated fiscal actions and a full range of monetary policy instruments.

• Strengthening the financial system by the introduction of stronger regulation and improvements to international cooperation.

• IMF recommendation to provide fiscal stimulus of 2 percent of GDP.

17

Canadian Economic Context, January 2009

18

Canadian banks were less leveraged than banks in other developed countries …Canadian banks were less leveraged than banks in other developed countries …

Bank Leverage Ratiosassets as a multiple of capital

Note: Based on data for the big six Canadian banks, seven major banks from the Euro area, six major UK banks and five large U.S. commercial banks. Canadian data are based on the regulatory ratio of assets (including some off-balance sheet items) to adjusted Tier 1 and Tier 2 capital. Leverage for other countries is measured as the ratio of balance sheet assets to shareholders' equity. Sources: Bloomberg; financial statements.

15

20

25

30

35

2000 2001 2002 2003 2004 2005 2006 2007 2008

Canada US

UK Euro area

19

Tier 1 Capital Ratio(Tier 1 capital as a percentage of risk-weighted assets)

5

6

7

8

9

10

11

2000 2001 2002 2003 2004 2005 2006 2007 2008

U.S (Commercial Banks)

Canada

U.K.

EU

Source: Bloomberg and bank financial statements

… and were also more highly capitalized … … and were also more highly capitalized …

20

… but the global credit crisis was still affecting credit markets in Canada. … but the global credit crisis was still affecting credit markets in Canada.

Business Lending Conditions

Note: Pricing conditions refer largely to the cost of borrowing, whereas non-pricing conditions refer to access to credit and lending terms. The balance of opinion is calculated as the weighted percentage of respondents reporting tightened credit conditions minus the weighted percentage reporting eased credit conditions.

Source: Bank of Canada - Senior Loan Officer Survey.

balance of opinion, percentage points

-60

-40

-20

0

20

40

60

80

100

1999 2001 2003 2005 2007 2009

Price

Non-priceterms

Easing

Tightening

21

Household balance sheets were in better shape in Canada than in the United States … Household balance sheets were in better shape in Canada than in the United States …

Net Worth to Personal Disposable Income

Sources: Statistics Canada; Department of Finance.

4.0

4.5

5.0

5.5

6.0

6.5

1990Q1

1993Q1

1996Q1

1999Q1

2002Q1

2005Q1

2008Q1

Canada

U.S.

ratio

12

14

16

18

20

22

24

26

28

1990Q1

1992Q3

1995Q1

1997Q3

2000Q1

2002Q3

2005Q1

2007Q3

U.S.

Canada

Household Debt to Net Worth

ratio

Source: U.S. Federal Reserve Board, Statistics Canada.

22

… but the decline in consumer confidence still pointed to some likely retrenchment. … but the decline in consumer confidence still pointed to some likely retrenchment.

Consumer Confidence

20

40

60

80

100

120

140

160

1978Q1 1984Q1 1990Q1 1996Q1 2002Q1 2008Q1

Canada

U.S.

Index, 2002=100 for Canada, 1985=100 for U.S.

Sources: The Conference Board of Canada; The Conference Board.*2009Q2 data is preliminary as it includes only April 2009.

23

Canadian public finances were in good shape …Canadian public finances were in good shape …

15

20

25

30

35

40

45

50

55

60

2006 2007 2008 2009 2010

Canada

G7 average

Total Government Net Debt to GDP Ratio

per cent

Federal Net Debt

0

10

20

30

40

50

60

70

80

1979-1980 1989-1990 1999-2000 2009-2010

per cent of GDP

Actual Forecast

Sources: Department of Finance; Statistics Canada.Public Accounts basis.

Source OECD Economic Outlook (March 2009 update); Department of Finance calculations.National Accounts basis.

24

… but that could not shield Canada from a U.S. recession. … but that could not shield Canada from a U.S. recession.

U.S. Real Final Domestic Demand and Canadian Real Exports Growth

per cent

-4

-2

0

2

4

6

8

1981 1990 1999 2008

Canada - Real Exports

U.S. - Real Final Domestic Demand

In 2008, 73% of Canadian exports went to the U.S.

Sources: Statistics Canada; U.S. Bureau of Economic Analysis.

25

World commodity prices had collapsed …World commodity prices had collapsed …

Commodity Prices (in U.S. dollars)

index 1997=100

Source: Department of Finance Commodity Price Index.Note: April 2009 includes data up to April 24, 2009.

index 1997=100

75

100

125

150

175

200

225

Jan 2002 Jan 2003 Jan 2004 Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009

50

150

250

350

450

550

650

Total (left scale)

Non-Energy (left scale)

Energy (right scale)

26

… Canada’s exports had declined sharply … … Canada’s exports had declined sharply …

Exports and Imports Levels

$ billions, annual rates

0

50

100

150

200

250

300

350

400

450

500

550

600

650

92Q1 95Q1 98Q1 01Q1 04Q1 07Q1

Exports of goods and services

Imports of goods and services

Exports fall by 10% in Q4; imports fall by 2%

27

Growth Per Capita Real Gross Domestic Income

per cent

Sources: Statistics Canada; Department of Finance.

… real income (GDI) had declined sharply … … real income (GDI) had declined sharply …

0

5

10

15

20

25

2002 2003 2004 2005 2006 2007 2008

Real GDP per capita

Real GDI per capita

U.S. up just 7.3% over the same period; over 15% in Canada

28

2

4

6

8

10

12

14

Jan1976

Jan1979

Jan1982

Jan1985

Jan1988

Jan1991

Jan1994

Jan1997

Jan2000

Jan2003

Jan2006

Jan2009

Canada

U.S.

… and employment losses had already begun. … and employment losses had already begun.

55

57

59

61

63

65

67

Jan1976

Jan1979

Jan1982

Jan1985

Jan1988

Jan1991

Jan1994

Jan1997

Jan2000

Jan2003

Jan2006

Jan2009

Canada*

U.S.

per cent

* Calculated using U.S. methodology.

Unemployment Rates

per cent

Employment Rates

Sources: Statistics Canada, U.S. Bureau of Labor Statistics.

29

A Budget Designed for the Times

30

(My) Three Themes:

1. Financial-Market Measures

2. The Dual Need for Fiscal Stimulus

3. The Importance of Fiscal Prudence

31

Theme 1: Ensuring a Sound Financial SystemTheme 1: Ensuring a Sound Financial System

The Government had taken some actions in 2008 to strengthen the financial system.

Budget 2009 established the Extraordinary Financing Framework, containing several measures.

32

The Extraordinary Financing FrameworkThe Extraordinary Financing Framework

Insured Mortgage Purchase Program $125 billion

New 10-year Canada Mortgage Bond $10 billion

Canadian Lenders Assurance Facility

-

Canadian Life Insurers Facility -

Expanded Activities for EDC and BDC $13 billion

ABS Facility (by EDC) $12 billion

(excluding actions by Bank of Canada)

33

Potential concerns with the EFF?Potential concerns with the EFF?

1. Efficiency of government involvement in allocation of credit?

2. What is the exit strategy?

34

Target for Overnight Interest Rateper cent

0.0

1.0

2.0

3.0

4.0

5.0

Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09

Canadian monetary policy had already been very aggressive …Canadian monetary policy had already been very aggressive …

35

… but rate reductions had not always been reflected in credit markets … … but rate reductions had not always been reflected in credit markets …

basis points

Change in Interest Rates Since September 2007*

*As of the week of April 22, 2009.

Basis points

Policy Rates

1-year mortgage rates

5-year mortgage rates

10-year + corporate bond

Canada

U.S.

-425

-285

-174

121

-500

-78

-130

137

-600 -400 -200 0 200

36

… and perhaps would not be sufficient anyway. … and perhaps would not be sufficient anyway.

Consumer Confidence Business Confidence

Index, 2002=100 diffusion index (50=no growth)

Sources: The Conference Board of Canada, Institute for Supply Management (ISM) non-manufacturing survey.

20

40

60

80

100

120

140

98Q1 00Q1 02Q1 04Q1 06Q1 08Q130

35

40

45

50

55

60

65

Canada (left)

U.S. (right)

20

40

60

80

100

120

140

160

1978Q1 1984Q1 1990Q1 1996Q1 2002Q1 2008Q1

Canada

U.S.

Index, 2002=100 for Canada, 1985=100 for U.S.

Sources: The Conference Board of Canada; The Conference Board.*2009Q2 data is preliminary as it includes only April 2009.

37

1. Dampen the economic slowdown

2. Protect the most vulnerable Canadians

Suggested a targeted mix of spending and tax measures

Theme 2: A dual need for fiscal stimulusTheme 2: A dual need for fiscal stimulus

38

Short-Run Expenditure and Tax MultipliersShort-Run Expenditure and Tax Multipliers

*Dollar impact on the level of real GDP after 8 quarters of a permanent one dollar increase in fiscal measures.

1.7 1.6 1.5

1

0

0.5

1

1.5

2

Measures for low-income households

Infrastructureinvestment

Housing investmentmeasures

Personal income taxmeasures

Measures for low-income households include: all EI measures, training for non-EI eligible clients, wage earner protection program, increase to the National Child Benefit and Canada Child Tax Benefit, and enhancement to WITB.

39

1. Provincial, territorial and municipal infrastructure

• Direct, low-cost loans to municipalities for projects

2. Federal infrastructure

3. First Nations infrastructure

4. “Knowledge” infrastructure• PSE, CFI, electronic health records, broadband

5. Social housing for low-income Canadians

6. Support for home ownership and renovation

New spending combined infrastructure and housing measures … New spending combined infrastructure and housing measures …

40

… with a variety of “sectoral” measures. … with a variety of “sectoral” measures.

• Capital Cost Allowance• Computers

• Manufacturing and processing M&E

• Tariff relief on machinery and equipment

• Sectoral adjustment• Community Adjustment Fund

• Support to automotive sector in collaboration with Ontario

• Support for culture and the arts

• Clean energy technologies

• Support to small businesses

41

Income-tax cuts were aimed at low- and middle-income earners.Income-tax cuts were aimed at low- and middle-income earners.

1. Significant personal income tax relief

• Increases in basic personal amount

2. Increases to the National Child Benefit and Canada Child Tax Benefit

3. Doubling the tax relief provided by the Working Income Tax Benefit (WITB)

• Reduction in MTR for very-low-income earners

4. Increase to the Age Credit amount

42

• EI benefits strengthened:• Expansion of work-sharing

• Extra five weeks of EI benefits

• Additional benefits for participants in longer-term training

• Enhanced availability of training:• Additional support for training programs

• Targeted support for older workers

• Apprenticeship completion grant introduced

• EI contribution rates were frozen for 2009 and 2010

Labour-market measures also figured prominently.Labour-market measures also figured prominently.

43

A $40 billion stimulus package (over 2 years)A $40 billion stimulus package (over 2 years)

Tax measures account for $10.1 billion of total stimulus

Spending measures represent $29.9 billion of total stimulus

2009 2010 Total(billions of dollars - cash basis)

EI changes, Personal tax reductions, Skills and Training

5.9 6.9 12.8

Tax measures to support housing, Social housing investments

5.4 2.3 7.8

Infrastructure programming 6.2 5.6 11.8

Tax and Tariff changes, Sectoral adjustment measures 5.3 2.3 7.5

Total Federal Stimulus 22.7 17.2 39.9

Total Stimulus (with Leverage) 29.3 22.3 51.6

As a share of GDP (%)

Total federal stimulus 1.5 1.1 2.5

Total stimulus (with leverage) 1.9 1.4 3.2

44

• The low debt-to-GDP ratio suggested to many that the government could have done much more than it did:

• Bigger increase to spending

• Bigger tax reductions or EI improvements

• Could it?

Theme 3: The importance of fiscal prudenceTheme 3: The importance of fiscal prudence

45

Debt-to-GDP Ratio: 68 29 in 14 yearsDebt-to-GDP Ratio: 68 29 in 14 years

(Net) Debt-to-GDP Ratio

per cent of GDP

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002-03 2004-05 2006-07 2008-09 2010-11 2012-13

Projection Actual

46

Actual and projected budgetary balanceActual and projected budgetary balance

-6.0

-4.0

-2.0

0.0

2.0

4.0

1990-91 1993-94 1996-97 1999-00 2002-03 2005-06 2008-09 2011-12

per cent of GDP Projection Actual

Budgetary Balance-to-GDP Ratio

47

1. Infrastructure is difficult to scale up

2. Tax cuts and EI changes are difficult to reverse

Government struck a balance between what was feasible and what was affordable over the medium term

Can policies be scaled up or reversed?Can policies be scaled up or reversed?

48

… to ensure that G/GDP comes back to current levels in the medium term.

… to repay the current deficits once surpluses return.

… over the next 10 years to prepare for the coming fiscal challenges caused by demographic change.

Fiscal discipline will be necessary …Fiscal discipline will be necessary …

Summary

50

The 2009 budget was designed to:The 2009 budget was designed to:

• Improve Canadians’ access to credit and restore their confidence in the financial system;

• Dampen the slowing effects of the global recession;

• Protect and assist the most vulnerable individuals during these challenging times;

• Retain Canada’s hard-won fiscal prudence so that we are prepared for future challenges.

51

Measures to accelerate Budget ImplementationMeasures to accelerate Budget Implementation

• BIA 2009 received Royal Assent on March 12th (compared to June 18th for BIA 2008)

• Included $7.6 billion in spending authority for a range of measures, many of which would normally be funded through the annual appropriations process

• Streamlined process for Cabinet and Treasury Board consideration and approval

• New Central Vote in the Main Estimates allows for the release of Budget 2009 funds between April and June subject to Treasury Board approval

• Spring Supplementary Estimates expected to be tabled in mid-May with supply obtained early June

Thank youThank you