Bank of Canada Governor Poloz said that the lowered private sector forecasts he was seeing were little more than arithmetic and promised to unveil new projections on April 15th from the Bank of Canada's forecasting team, which he described as "the best there is". He suggested that more than just doing arithmetic, the Bank of Canada's forecasters would take account of confidence effects and how behavior might change in the post-Covid19 world. One suspects that the Bank will provide a range of scenarios based on differing assumptions about the course of the Covid19 pandemic and the likely economic repercussions of a shorter or longer crisis.
Many questions are not answered, or even addressed, in these forecast revisions. Will government support programs and a huge increase in deficit spending prevent corporate defaults and a permanent destruction of economic capacity. If debt defaults are too large, will that tigger persistent higher unemployment and unleash deflationary forces? Will Canada's highly productive energy industry be able to recover when government policies are tilted toward "phasing out" fossil fuels? Will financial markets take in stride the coming huge spike in Canada's federal debt-to-GDP ratio, or will investors demand a higher credit risk premium for a country which already has very high levels of household and corporate debt? Will the Bank of Canada's policy interest rate setting stay at the effective lower bound indefinitely, and if so, will bond markets anticipate higher inflation and bond yields? Perhaps the Bank of Canada's crack forecasting team will shed some light on these questions. But probably not.Having read the Bank of Canada's April Monetary Policy Report, I must admit that I am not surprised that most of the questions posed above were not addressed. As noted in the MPR, the future course of Covid19 is still too uncertain to make projections with any precision. As I suspected, the BoC chose to provide a range of scenarios based on differing assumptions about the course of the pandemic and the eventual relaxation of containment measures. I was surprised, however that while the MPR did provide charts showing a range of plausible projections for the level of real GDP and CPI inflation, it did not provide any numerical projections.
However, from the charts provided by the MPR, we can extract the Bank's most optimistic and most pessimistic projections and they are very surprising.
First, a digression. When I started my career as an economist straight out of graduate school in 1977, I went to work at The Conference Board of Canada. At the time, the Conference Board had Canada's only private sector quarterly econometric model forecast. The Board had a very strong team of forecasters and its' quarterly forecasts were presented at large conferences for members, quite often with up-and-coming economists from the Bank of Canada in attendance. I worked at the Board from 1977 to 1980, helping out with the forecast and publishing a number of research reports. These forecasts and research reports had lots of charts and graphs. We had a big mainframe computer that could print out the tables with all of the forecast numbers, but computer graphic printers had not yet been perfected. Instead, we had a chart room, which employed numerous graphic artists who toiled all day grinding out the charts using graph paper, rulers, light tables and all the many tools of their trade. Remembering those days, one can use a ruler and a pencil and reverse engineer the Bank of Canada's charts in the MPR to come up with the data points for their most optimistic and pessimistic scenarios.
When one goes to the trouble to do that, one gets a surprise, as shown in the chart below. In the chart, I compare the BoC's projections with the pre-Covid19 path of potential GDP and with forecasts made in late March by TD Economic Research and by the Parliamentary Budget Office which were shown in my previous post.
The surprising thing about the BoC projections is that even the Optimistic projection shows a far deeper plunge in real GDP in the first half of 2020 than the worst private sector forecasts. In the MPR press conference Governor Poloz said that he thought the Optimistic projection was attainable if containment measures started being relaxed in late May or early June. The Pessimistic projection, which contemplates a later relaxation of containment measures, shows the level of real GDP collapsing by more than three times as much as either the worst private sector forecast or the forecast used by the Parliamentary Budget Office when it projected a C$182 billion deficit for FY2020-21.
The BoC's Optimistic real GDP projection works out to be a contraction of about 6.5% in 2020 followed by about a rebound to about 8.5% growth in 2021. The average forecast from the economists of Canada's big banks in early April was for a contraction of about 4% in 2020 followed by a slightly better than 4% rebound in 2021. For comparison, the latest IMF forecast for Canada calls for a contraction of 6.2% in 2020 (very similar to the BoC's optimistic scenario) followed by a 4.2% rebound in 2021 (very similar to the private sector bank forecasts). The BoC's Pessimistic projection is horrendous, calling for a 19% contraction in 2020, followed by a 4% rebound in 2021.
Another way to view the Bank's projections is to convert them into projections of the output gap, i.e. the gap between projected GDP and potential GDP, which was assumed to be growing at about 1.7% before Covid19. The chart looks similar, but the scale shows that while TD Economics and the PBO expected economic activity to fall about 10% below previous estimates of its' potential, the BoC expects real GDP to fall, optimistically, 15% or, pessimistically, 30% below potential before beginning a quick or slow recovery. In the Optimistic projection, real GDP recovers to near full capacity by the end of 2021. In the Pessimistic projection, real GDP would still be almost 15% below its pre-Covid19 potential at the end of 2021, an outcome which would surely be called a depression.
No wonder the Bank of Canada decided not to publish numerical projections! Doing so would probably have been a shock to the already battered confidence of Canadian businesses and consumers. It would also have implied a much larger budget deficit than that projected by the Parliamentary Budget Office.