Earlier this week the Bank of Canada released their summer 2008 Business Outlook Survey. Not surprisingly, optimism about the future is higher in resource producing provinces than in provinces that export finished goods and services to the United States:
“On balance, firms located in Western Canada are expecting an increase in sales growth over the next year, while those based in Central and Eastern Canada are expecting sales growth to slow. Overall, strong commodity prices and expectations of still-healthy domestic demand are helping to offset the negative effects of a weak U.S. economy and a strong Canadian dollar on the sales outlook.”
Dutch Disease is hitting Ontario, in particular, hard. The province saw a 0.3 percentage point decrease in real GDP during the first quarter due to the related effects of higher commodity prices and a continued high Canadian dollar. And the problem may be getting worse – of particular concern is that the loonie is likely undervalued given the current level of oil prices.
The conventional wisdom is that, on net, high oil prices benefit the Canadian economy, and any harm done to Quebec and Ontario is offset by gains from Western Canada. But in a report issued yesterday (PDF) Douglas Porter, Deputy Chief Economist of BMO Capital Markets, suggests that any further rise in oil prices is likely to be detrimental to Canada:
“There is a strong case to be made that the surge in oil and gas prices crossed the tipping point this spring from providing some economic ballast for the domestic economy to acting as a heavy anchor… While it would no doubt be painful for the previously resilient TSX and Canada’s merchandise trade surplus, lower energy costs would remove a tremendous burden from the U.S. and global economy and would take some of the pressure off simmering inflation pressures.”
Canada, with its North-South tradeflows and reliance on unequally geographically distributed commodities is far from a optimum currency area . This presents particular difficulties for the Bank of Canada. Interest rate cuts would weaken the dollar and promote growth in Ontario, but would also accelerate the commodity price inflation coming from the West; the Bank of Canada (BoC) has a strict mandate to keep inflation between 1 to 3 percent.
There is, however, almost no demand for drastic changes in Canadian fiscal policy coming from Canada’s manufacturing heartland. It would appear that any potential policy, from removing the BoC’s inflation containment mandate to a return to fixed exchange rates are seen as being inferior to the status quo.
Mike Moffatt is the Economics Guide for About.com.