Canada

OECD Economic Outlook, Dec, 1996

Prospects

The economy is projected to expand at an annual rate of 3 to 3 1/2 per cent from the second half of 1996, as the monetary easing that has taken place over the past eighteen months boosts domestic demand while exports continue to increase at a healthy pace. Although the expected slowdown in the United States implies somewhat slower growth of Canada's export markets, further gains in market share seem likely, given the country's favourable competitive position. Low interest rates, improving consumer confidence and substantial pent-up demand should underpin household spending on housing and consumer durables. Business investment is expected to become more broadly based, as spending on structures and in domestic-oriented industries strengthens. Despite significant job creation in the private sector, unemployment is projected to decline only gradually, remaining above its estimated structural rate. With potential output growth at just over 2 1/2 per cent per annum, the projections imply a narrowing but persisting output gap. As a result, the annual increase in the consumer price index is expected to remain within the lower half of the official 1 to 3 per cent target range. With a pick-up in import growth limiting further improvements in the foreign balance, the current account is projected to stay in slight surplus.

While this would seem to be the most likely outcome, the growth profile could be less even than projected. Consumer confidence - albeit recovering - is still fragile, and the contraction in public spending that is under way could have a larger adverse effect on near-term activity than currently envisaged. Conversely, given substantial pent-up household demand and low inventory levels, growth could also pick up more strongly than expected. Such a scenario would not seem to involve major inflation risks, although the implied faster closing of the output gap might call for some tightening in monetary conditions towards the end of the projection period. In addition, unexpected changes in the economic and policy environment in the United States could have a substantial effect on economic prospects for Canada. A risk to the US outlook appears to be that demand will not slow significantly, prompting a larger-than-anticipated tightening in monetary policy. While boosting Canadian exports in the short run, such a scenario might complicate the task of monetary policy in Canada, especially if domestic economic conditions warranted further monetary easing.

Fiscal policy assumptions underlying the projections

Fiscal projections are based on the March 1996 Federal Budget and the October Economic and Fiscal Update, which call for the deficit (on a public accounts basis) to fall to levels corresponding to 3 per cent, 2 per cent and 1 per cent of GDP in the fiscal years (starting in April) 1996/97, 1997/98 and 1998/99, respectively. The projections adjust the Federal Budget figures to a calendar year basis and to national accounting conventions, and further adjust revenues and expenditures in light of differences between OECD Secretariat and national projections for growth and interest rates. The fiscal situation of the provinces is expected to be consistent with their 1996 budgets, which imply a combined deficit (public accounts basis) of 1 1/2 per cent of GDP for 1996/97, largely accounted for by Ontario and Quebec. From 1997, the fiscal projections are based on the provinces' legislated or stated medium-term objectives, which in the case of Ontario and Quebec call for an elimination of budget deficits by 2000/01 and 1999/2000, respectively. Although some budget cuts have still to be identified - especially at the provincial level - fiscal plans are expected to be met, as they are generally based on deliberately prudent economic assumptions and incorporate substantial contingency reserves.