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Unintended consequences of a global economy
October 19, 2021
Authored by RSM Canada LLP
Edwin P. Reilly, CPA, CA shared this article
INSIGHT ARTICLE |
Unintended consequence No. 1The first misstep was the lack of a consistent public health approach. This lack of disciplined policy underscored by the quick reopening of local economies and the U.S. withdrawing from the World Health Organization has given the coronavirus the time and means to mutate and spread. Now the recovery of the Canadian and U.S. economies is running into headwinds, first and foremost because the pandemic never really ended in all parts of the world. In addition, as we now exist in an interdependent world, with production in one place and consumption in another, the resurgence of the coronavirus outside the developed world is once more creating a supply crisis throughout developed economies. In its latest assessment, the Bank of Canada finds Canada's recovery to be choppy, with an abundance of uncertainty due to the fourth wave of COVID-19 infections and deaths. Though jobs have rebounded, the bank considers the recovery of the labour market to be uneven. (Statistics Canada attributes much of the latest increase in service-sector employment to the easing of public health restrictions in many jurisdictions.) Growth in the second quarter was weaker than expected, the bank said, as supply chain bottlenecks constrained manufacturing and exports. As such, consumption, business investment and government spending continued to fuel the recovery. Economists polled by Bloomberg have taken notice of the bottlenecks, halving their forecast for Canada's third quarter 2021 growth from a giddy annualized rate of 9 per cent down to 4.5 per cent. We suspect that with consumers unwilling or unable to purchase higher-priced goods, the negative impact on GDP will continue as long as the supply constraints exist. And because that will affect the profits of corporations, the stock market has become the canary in the coal mine. The U.S. S&P 500 equity market index lost nearly 4.8 per cent of its value during September, and the Toronto stock exchange lost 2.5 per cent.
RSM Canada Financial Conditions Index and financial conditions excluding commodities
MIDDLE MARKET INSIGHTThe Bank of Canada finds Canada's recovery to be choppy, with an abundance of uncertainty due to the fourth wave of COVID-19.
Unintended consequence No. 2The second unintended consequence of government policy relates to the public's demand for single family housing in response to the public health crisis. That demand has been fueled by the Bank of Canada's accommodative interest rate policy. The central bank has said that it will keep interest rates at extremely low levels for as long as slack remains in the economy. But will the unintended consequence of that accommodation turn on itself? Have low interest rates created an asset bubble that will endanger the financial health of overextended households? Therefore, while financial conditions are far from being too exuberant, there are nonetheless outcomes that need to be addressed by the fiscal authorities. Arguably, the low interest rates are contributing to a housing crisis for low- to middle-income households. Consider that suitable and affordable housing is as much a necessary condition for economic growth as are the health and education of the labour force. The Bank of Canada recently noted that housing market activity pulled back from recent high levels. And long-term interest rates have remained higher than their pandemic lows and have recently shown signs of moving higher in response to inflation concerns and the prospect for higher economic growth. Whether that helps cool the housing market does not alter the fact that ordinary people can no longer afford to live close to their work.
Canada and U.S. 10-year yields
The takeaway The coordinated response by the fiscal and monetary authorities to the shocks of the trade war and the pandemic has been remarkably effective. Their moves have averted what could have been an economic disaster. And the peculiar nature of the pandemic has both exposed societal fractures and provided time for both policymakers and businesses to consider matters beyond the normal course of discussion. It would be nice to think the trauma of the last two years is over. But we live in a global economy, and the incidence of public health crises has accelerated. In this global financial system, the spillover effects emanating from Beijing or Washington are likely to affect the course of Bank of Canada and government policies.
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