Canada Copes Well With Lower Oil Prices

  • Despite substantial oil shock, growth to rebound moderately in 2016
  • Focus on stimulating growth while safeguarding financial stability
  • Fiscal policy takes on bigger role through tax, expenditure measures
  • The Canadian economy has struggled for more than a year, as oil, a major Canadian export, lost more than half its value since 2014 and led to a slump in business investment, with energy firms scaling back investment plans. As a result, real GDP growth slowed to 1.2 percent in 2015.

    But 2016 will likely see the country return to growth at 1.7 percent and converge to potential growth of around 2 percent over the medium term, the report says.

    A supportive monetary policy and exchange rate depreciation have helped cushion the effects of the oil shock. Inflation remains low and the labor market has held up relatively well, with the unemployment rate edging up only slightly above the 7 percent mark (from about 6½ percent in late 2014). There are risks to this growth outlook, however, the report notes. The economic and financial effects of the oil shock have yet to fully play out and there are increasing financial vulnerabilities, as reflected in rising loan delinquencies, albeit from low levels.

    More broadly, the weaker economy has raised concerns about vulnerabilities related to the housing market. Low interest rates have fueled a rise in household debt.

    Stirring up policy mix: more fiscal, less monetary stimulus

    Given the weak economic environment, monetary policy needs to stay accommodative, and further interest rate reductions could be considered if the economy slows. It should not, however, solely bear the burden of supporting the economy, given potential financial stability risks associated with a low interest rate environment.

    Here, fiscal policy can step in to alleviate the burden on monetary policy in providing near-term demand support. In this regard, the IMF welcomes the stimulus measures in the 2016 federal budget that sharply boosts spending on a raft of initiatives from infrastructure projects to social benefits.

    With low government net debt (compared with the size of the economy) and borrowing costs, the report says that Canada has the space for fiscal expansion to support the economy. In addition, IMF staff’s debt sustainability analyses do not suggest major concern about debt dynamics under different stress scenarios.

    Wide regional differences

    At the provincial level, however, greater caution is needed. Among the larger...

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