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Through much of the 1990s, the unprecedented economic boom in the U.S. was a secret envy of Canadians. The U.S. also shared the economic benefits of its boom with us — not from an inherent altruism toward its northern neighbours, of course, but because of the mindless yet powerful forces of economic integration and trade. Nowadays, Canadians are hoping that somehow we will be spared from the consequences of those very same forces, as the U.S. economy, this time, plunges into recession.
The forces of sharing are pervasive, however, both in good times and in bad times. How, then, should Canadians calibrate their economic anxieties? Naturally, this depends on whether Canada shares the symptoms of the U.S. economic malaise, and on how deep the U.S. economic slowdown will be.
The possibility of a recession in the U.S. has made the headlines in recent weeks, but many economists, since at least last summer, have been warning about an impending U.S. recession. A long and unchecked credit expansion in the U.S., with mortgages at attractive “teaser rates,” allowed households to stretch their financial resources by buying increasingly more expensive houses — and, here is the fairy tale part — without even necessarily cutting back on their consumption expenditures. Lenders then turned around and repackaged these mortgages and sold them in the credit derivatives markets. Lured by overly optimistic anticipated yields, essentially by underpricing default risks, many financial firms hoarded these derivative securities. The outcome was a sustained housing bubble, which ultimately went bust and turned into the subprime mortgage crisis. Fortunately, the Canadian mortgage market does not share this malaise, at least for now. In fact, Canada has had the enviable position of posting strong output and employment growth rates largely due to an ongoing global commodity price boom.
But, much of this can change. We will not be able to insulate our economy from an economic slowdown in the U.S., which has been accounting for about 80 per cent of our exports since 2000. So, a more relevant issue for Canada is the severity of the expected recession in the U.S., and whether there is an unfolding global recession — a recession that could slash the commodity prices upon which the health of the Canadian economy depends so heavily.
While there is no quarreling among economists about the sources of the current financial debacle in the U.S., they are still unsure about the extent of this financial mess. Indeed, after the bursting of the housing price bubbles in the U.S. and elsewhere, bad economic news has been piling up, seriously raising the possibility of a global slowdown. The most recent estimates put the loss of housing equity in the U.S. above $3 trillion, and no one is sure that the prices have bottomed out yet. The residential construction sector is stalled, the non-manufacturing sector is showing signs of contraction for the first time in five years, unemployment claims are rising and, despite a depreciating U.S. dollar, the expansion in the manufacturing sector has been timid, at best. Even those who used to point to resilient U.S. consumers (the driver of economic growth in recent years), and praise the efficiency of financial markets (which greased the wheels of this growth) are scrambling to find good news.
Ironically, policy responses to a possibly severe recession have so far been the only “good” news. The Federal Reserve has cut its target interest rate aggressively to send a strong message of confidence. And, after a bi-partisan initiative, the White House has recently announced a tax rebate to send a message of hope. It is unclear whether this emergency fiscal and monetary policy package will be sufficient to prevent a U.S. recession.
While the turbulence in financial markets and the interest rate cuts generated spirited reporting, the press hardly noticed the return of countercyclical fiscal policy in the U.S. For more than three decades, there was no political will to smooth recessions through fiscal policy. For those of us who relentlessly think of governments as valuable providers of insurance against recessions, this fiscal policy response has been rather remarkable.
So far in Canada, fiscal and monetary policy responses have been muted. While prudence is a virtue and the Canadian economy currently has strong fundamentals, these should not prevent us from proactive policy-making — especially given that the economic fortunes of the U.S. turned around quickly, and the same might be happening to the global economy soon, Canada included. After all, good economics is about transforming cold-blooded statistical calculations into actions.
 | Talan Iscan is a professor of economics at Dalhousie University. |