World must adapt to slower growth, says bank deputy
Nearly a decade after the global financial crisis, economists and policy-makers of all stripes are still working to avoid another one.
But if and when it arrives, chances are it will present different problems and require new solutions.
“While we typically link financial stability risks to unsustainably high growth, slower growth and lower returns can also add to vulnerabilities in the financial system,” Bank of Canada senior deputy governor Carolyn Wilkins warned Wednesday.
“Given the added challenges of a number of sovereign debt crises, an oil price shock and — most recently — the unfolding fallout from Brexit, it’s understandable that we have devoted a lot of energy to avoiding another financial meltdown and keeping the recovery on track.”
In a speech to the Official Monetary and Financial Institutions Forum in London, Wilkins added: “We have to adapt to this new reality of lower potential growth. The faster we do this, the safer the financial system will be.”
That weakening in the global economy can be attributed to two factors — labour supply and productivity — which “are rising more slowly than in the past ... contributing to the slowdown in global potential growth,” according to the text of her speech. The central bank estimates that potential growth in global GDP has declined from a peak of five per cent in 2005 to slightly more than three per cent this year. A two-point decline in global output works out to US$1.5 trillion in lost value in 2006. In five years, if that pace of output continues, the figure could rise to US$9 trillion.
“Slow growth worries me as a central banker, not only because it reduces our room to manoeuvre to achieve our inflation target. It also worries me because slower potential growth materially increases risks to financial stability,” Wilkins said. “Natural by-products of slower potential growth are not only weaker corporate profits and dividends, but also a lower average rate of return on investments.”
This new normal also affects the so-called “neutral rate” — a policy term used to described the estimated lending level needed “to balance savings and investment when the economy is operating at potential.”
Currently in Canada, that level is estimated at 1.25 per cent, down from three per cent in the early 2000s, Wilkins noted.
Low interest rates during and after the 2008-09 recession “encouraged growth in household credit, leaving many highly indebted,” Wilkins said. Household debt among Canadians is now about 165 per cent of disposable income.
“As the average household in- come growth slows, we can expect that economic shocks — such as foreign demand shocks that reduce demand for exports or changes in commodity prices that adversely affect a country’s terms of trade — will result in more frequent and longer periods of shrinking incomes,” she said.
Any adverse shock could push household balances into negative.
Still, monetary policy should not be relied on to “solve everything,” Wilkins stressed.
Fiscal policy “can be a powerful tool to boost growth, from both the demand and supply sides.”