Summary
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Though Canadian excess supply reached the same level in the recessions of 2008-09 and 1990-91, the output gap this time around is actually of a far different stripe.
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Though the shock to the goods-producing sector was harsher than in 1990-91, this sector today accounts for a smaller weight of the Canadian economy. As a result, though the output gap in the two recessions might be similar, the shock to the economy was much more concentrated on this occasion. This means that monetary policy has responded to a shock that affected a lesser proportion of overall activity in the latest downturn.
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The Bank of Canada did its job by drastically lowering its key rate in order to absorb the shock of the financial crisis. However, now that the Canadian and world economies are in recovery mode, we believe that the “output gap” argument is crumbling more and more.
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In fact, at time of writing, service-sector employment in Canada has already bounced back to a new record high. This stands in sharp contrast with the situation witnessed in the United States.
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Given the ultra-accommodative level of Canadian monetary policy and the effectiveness of easing with respect to the labour market, we believe that a normalization of the Canadian key rate will be called for soon. We reiterate our conviction that authorities this side of the border will get the ball rolling in this regard beginning in April.
