Stimulus can’t fix oil slump

As if the Canadian economy were not suffering enough already, we are now forced to endure what The Canadian Press is calling the “cauliflower crisis.” The combined effects of drought in California and the falling Canadian dollar have caused the price of cauliflower to triple since the fall. “It’s just like a big, total disaster,” according to an importer quoted in the Toronto Star.

If the disaster seems less than total to you, it is because you have failed to keep pace with the media, who have suddenly descended into one of their periodic fits of panic at the state of the economy — described in just the last 24 hours as “failing,” “dire,” “gloomy,” and “worsening,” not to mention teetering “on the edge of another downfall.”

Things are not quite as hysterical as in France, where the government has just declared “a state of economic and social emergency,” but give them time.

And yet the evidence in support of this latest outbreak of mass despondency is scant. The stock market, to be sure, is off sharply, but the stock market is not the economy. Neither is the dollar. A falling dollar certainly imposes costs, such as pricier cauliflower, but it also brings benefits. It is not, in itself, a benchmark of our economic health.

By the more conventional measures the economy is not failing or falling, but merely flagging. GDP growth in the third quarter was 2.3 per cent annualized, and while there is some sense that it grew rather less robustly in the fourth, there is no evidence of recession.

Unemployment, at 7.1 per cent, is slightly higher than it was a year ago, but lower than at most times in the last 40 years. To the extent it has risen, moreover, it is because of growth in the labour force, not declining employment: the economy added 158,000 jobs last year.

Earnings, industrial output, capacity utilization: all indicate an economy that is growing slowly, not declining. That’s hardly grounds for celebration, but neither does it support the kind of crisis mentality that has developed.

Moreover, the rate of growth is very different in different parts of the country. While Alberta and other oil- producing provinces have been hard hit, Ontario is growing: 3.5 per cent annualized in the third quarter. Exports, likewise, grew at a nearly three-per-cent rate, reflecting the cheaper dollar’s effect on the competitiveness of Canadian goods and services.

All of which makes it hard to justify the recent eruption of demands for fiscal stimulus, largely from Bay Street economists. Whatever the arguments about fiscal policy’s effectiveness in countering deep and lasting recessions, of a kind the world faced in 2008, it was never envisaged that it should be wheeled out the minute economic growth fell below two per cent.

And whatever its uses in cases of insufficient aggregate demand, as the economist Stephen Gordon has lately reminded us, it is wholly inappropriate to invoke it against what is in reality a shock to aggregate supply: the sudden drop in the price of oil has taken a sizable bite out of Canada’s productive capacity, just as the equally sudden spike in the price of oil did to the United States’ economy in the 1970s. It was a bad idea to treat a supply problem with a demand solution then, and it is just as bad an idea now.

Of course, it’s open to question whether fiscal policy is effective even at the best (i.e. worst) of times.

There’s a reason why Keynesianism had fallen out of favour among economists prior to the financial crisis. The model on which it was based is a marvel of restrictive assumptions: an economy that is closed to trade, expectations about inflation that are essentially myopic, interest rates that are largely impervious to the demand for credit and investment that is largely impervious to interest rates. Relax these, as economists had in the intervening decades, and whatever stimulative effect a burst of government spending might be imagined to have is very quickly unwound, especially in an open economy such as Canada’s.

If the deficit is financed internally, it leaves that much less capital available to private investment. If instead it is financed with imports of foreign capital, it drives up the exchange rate, which drives down exports.

If expectations are forward looking, and if economic agents think some part of the debt will have to be paid for by printing money, higher interest rates might be the result, or higher wages. If expectations are very forward looking, people might even look at the deficits as future tax increases, and offset public spending by increases in private saving.

All of which means estimates of the “multiplier” effect of government spending, at least in Canada, are not meaningfully different from zero.

The reason Keynesianism got such a boost post- crisis was not for any real- world examples of its success — the list of its failures, by contrast, is lengthy — but because of the assertion, accepted far too quickly with far too little evidence, that monetary policy, at the fabled Zero Lower Bound (interest rates of near zero) had lost its effectiveness.

In fact the last seven years have proved the opposite. Not only did the Zero Lower Bound turn out to be not so debilitating as all that — rather than work their will via interest rates, central banks took to injecting money directly into the economy via large- scale asset purchases — but it does not even seem to be the lower bound: central banks, notably in Europe, have successfully experimented with negative interest rates.

But not even monetary policy was designed to deal with changes in the relative prices of commodities, such as oil. In his recent speech, Bank of Canada governor Stephen Poloz noted, “There is no simple policy response in this situation. The forces that have been set in motion simply must work themselves out.”

Just so. Now if someone would just pass the word to Bay Street.