Canadian Policy Responses to the Global Financial Crisis and

Economic Recession

Lawrence Schembri

International Department

May 7 2009

For presentation at the Canada Day conference, Rimini Centre for Economic Analysis, Rimini, Italy

The views expressed in this presentation reflect those of the author and not the Bank of Canada

Why is the Canadian experience interesting & worthy of attention?

1. Canada entered the crisis in much better shape

2. Canada adopted the right policies at the right time.

3. Canada will recover faster, despite being in a not-so-good neighbourhood

Bottom line:

1. Important lessons can be learned from Canada

2. The crisis will instigate useful reforms to domestic and international policy

2007: Going into the Crisis

Government debt to GDP ratio was fallingAnnual Debt to GDP

40

60

80

100

120

140

160

180

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

40

60

80

100

120

140

160

180

Japan Germany Italy Canada USA

%

Source: OECD

Taxes were decliningAnnual Government Tax Revenue/GDP

24

26

28

30

32

34

36

38

40

42

44

46

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

24

26

28

30

32

34

36

38

40

42

44

46

Japan Germany Italy USA Canada

%

Source: DataStream

Inflation was stable & inflation expectations were well anchored

Annual Canadian Inflation

0.5

1

1.5

2

2.5

3

3.5

4

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

0.5

1

1.5

2

2.5

3

3.5

4

Core Inflation Headline Inflation Consensus Forecast

%

Source: StatsCan,Consensus Economics

Commodity prices were rising and the loonie was strong

Annual Commodity Prices and Effective Canadian Dollar Index

40

60

80

100

120

140

160

180

200

220

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

40

60

80

100

120

140

160

180

200

220

CERI BCPI

1995=100

Source: Bank of Canada

Consumer debt levels were also rising, but not too fast

Annual Household Debt/GDP and Debt Service Ratios

6

7

8

9

10

11

12

13

14

15

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

40

60

80

100

120

140

160

Canadian HH DSR (LHS) US HH DSR (LHS)Canadian HH Debt/GDP (RHS) US HH Debt/GDP (RHS)

% %

Source: StatsCan, Federal Reserve

House prices were rising, but not bubbling

Annual House Price Indices

0

50

100

150

200

250

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

50

70

90

110

130

150

170

190

210

230

250

Ireland Spain Canada USASource: National Bank, S&P,Bank of Spain, Global Insight

2000=100

Bank leverage ratios stayed calmAnnual Leverage Ratios - Major Banks

10

15

20

25

30

35

40

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

10

15

20

25

30

35

40

Euro Area US UK CanadaSource: Bloomberg

Crisis Chronology

1. Financial Crisis began: August 2007

2. U.S. Recession began: December 2007

3. Lehman Bros Collapse: September 2008

4. Synchronized Global Recession: 2008Q4 and 2009Q1

Global banks lost moneyAnnual Bank Writedowns

0

50

100

150

200

250

300

350

400

450

Canada US UK Italy Germany Japan

0

50

100

150

200

250

300

350

400

450

2007 2008 2009Source: Bloomberg

US$ Blns

Note: 2009 Figures are YTD

Deleveraging took hold and economies contracted

Quarterly GDP Growth Rates

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

16

07q3 07q4 08q1 08q2 08q3 08q4 09q1

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

16

USA UK Euro Area Japan Canada China

% Q/Q AAR

Source: Bank of Canada, StatsCan,Bank Calculations (China)

Canadian Policy Responses

• Financial Sector

• Fiscal Policy

• Monetary Policy

Financial Sector Policy

1. Liquidity provision (Bank of Canada) 2. Bank liability guarantees (Government of

Canada) – “Lenders Assurance Facility”3. Support for credit markets (Government

of Canada)4. NOT NEEDED - Removal of toxic

assets / bank capital injections

Liquidity Facilities

• The Bank of Canada has introduced several new facilities to provide liquidity to capital market participants:

1. Swaps of high quality, but less liquid assets for short-term government bonds

2. Collateralised loans• Key innovations: Wider sets of participants and

acceptable collateral

Credit Market Support

1. CDN $125B Insured Mortgage Purchase Program

2. Additional CDN $13B for Export Development Canada, Business Development Bank of Canada, and several other Crown corporations to facilitate trade and business credit

3. CDN $12B Canadian Secured Credit Facility, to support vehicle leasing through purchases of Asset Backed Securities

Daily Spreads between 3-month Interbank Offered Rates and Overnight Index Swap Rates*

0

50

100

150

200

250

300

350

400

Jul07 Sep07 Nov07 Jan08 Mar08 May08 Jul08 Sep08 Nov08 Jan09 Mar09

0

50

100

150

200

250

300

350

400

Canada US Europe UK* Canada: CDOR, US and UK: LIBOR, and EU: EURIBORSource: Bloomberg; last observation end of day 1 May 2009

bps

Canadian Fiscal Stimulus

1. Approximately CDN $40B or 2.5% of GDP 2. 60% will be infrastructure spending

3. 55% will be spend in 2009 and 2010

4. CDN $8.0B in permanent personal and corporate tax cuts

5. Leverage infrastructure/community spending with the provinces to reach CDN $50B

Monetary Policy Actions1. Aggressive interest rate cuts: 425 basis

points in 16 months to a target overnight rate of 0.25%

2. Unconventional policy measures• Conditional statement: hold rates at this level

until 2010Q2 conditional on inflation outlook• Term Purchase and Resale Agreements (6-12

months in duration)• Framework for credit and quantitative easing

Monthly Canadian Policy Rates and Inflation

0

1

2

3

4

5

6

7

Jan 04 Jul 04 Jan 05 Jul 05 Jan 06 Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 Jan 09

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

Target Rate Prime Lending Rate Core Inflation

%

Source: StatsCan, Bank of Canada

Daily Monetary Authority Policy Rates

0

1

2

3

4

5

6

2005 2006 2007 2008 2009

0

1

2

3

4

5

6

Canada USA Euro Area UK

%

Source: National Monetary Authorities

Aside: Credit and Quantitative Easing

• Quantitative easing -- outright purchase of government or private sector assets with central bank reserves

• Credit easing -- outright purchase of private sector assets with the sale of other central bank assets (sterilized purchases) or in conjunction with quantitative easing and the creation of central bank reserves (unsterilized purchases)

Figure 1: Financing and Type of Asset Purchases

Annex on “Framework for Conducting Annex on “Framework for Conducting Monetary Policy at Low Interest Rates” Monetary Policy at Low Interest Rates”

Outlook

Quarterly Canadian GDP Growth Forecast%

Annualized Quarterly Growth %

U.S. demand composition should be more favourable to Canadian exports

Projection for Total CPI Inflation

Lessons for Domestic Policy

• Macroprudential oversight of financial system

• Mitigate procyclicality in banking regulation

• National securities regulator

• Monetary policy at low interest rates

• Monetary policy should not ignore financial stability concerns

Lessons for International Policy1. Financial Stability Board - Bigger and Tougher

• Common standards/rules for financial sector

• College of supervisors of global financial institutions (peer review process)

• Crisis resolution procedures for ``too big to fail``

2. IMF – More resources and More Candid• + US$500B; New instruments: Flexible Credit Line

• Better external and internal governance

• Address financial stability; early warning system

Extra Slides

Commodity prices were rising and the loonie was strong

Annual Energy Prices and Canadian/US Exchange Rate

0.6

0.7

0.8

0.9

1

1.1

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

40

80

120

160

200

240

280

320

360

400

440

480

520

Exchange Rate (LHS) Energy Prices (RHS)

1995=100

Source: Bank of Canada

Daily Spreads between 1-month Interbank Offered Rates and Overnight Index Swap Rates*

0

50

100

150

200

250

300

350

Jul07 Sep07 Nov07 Jan08 Mar08 May08 Jul08 Sep08 Nov08 Jan09 Mar09

0

50

100

150

200

250

300

350

Canada US Europe UK* Canada: CDOR, US and UK: LIBOR, and EU: EURIBORSource: Bloomberg; last observation end of day 1 May 2009

bps

Daily Canadian Corporate Bond Index Option-Adjusted Spreads

0

50

100

150

200

250

300

350

400

450

500

550

Jan07 Mar07 May07 Jul07 Sep07 Nov07 Jan08 Mar08 May08 Jul08 Sep08 Nov08 Jan09 Mar090

50

100

150

200

250

300

350

400

450

500

550

A BBB AASource: Merrill LynchLast observation end of day 1 May 2009

bps

Weekly Par Value Outstanding for BoC Liquidity Facilities

0

5

10

15

20

25

30

35

40

S O N D J F M A

C$ (blns)

0

5

10

15

20

25

30

35

40

Term PRA Term Loan Facility & Term PRA for Private Sector Instruments

* Outstanding values as of Thursday each week; final value is for 30 April, 2009

Source: Bank of Canada

Share of real

global GDPa

(per cent)

Projected growth (per cent)b

2008 2009 2010 2011

United States 22 1.1 (1.2) -2.4 (-1.7) 1.2 (2.6) 2.9

European Union 20 0.7 (0.9) -3.6 (-1.0) -0.2 (2.1) 1.8

Japan 7 -0.7 (0) -6.2 (-1.7) 0.1 (2.0) 2.5

China and Asian NIEsc

14 7.1 (7.5) 3.5 (5.6) 6.0 (6.9) 7.3

Others 37 4.9 (5.0) 1.0 (2.7) 3.0 (4.3) 4.0

World 100 3.2 (3.4) -0.8 (1.1) 2.2 (3.7) 3.7

a. GDP shares are based on IMF estimates of the purchasing-power-parity (PPP) valuation of country GDPs for 2006. Source: IMF, WEO Update, October 2008.

b. Numbers in parentheses are projections from the January 2009 Monetary Policy Report Update.c. NIEs are newly industrialized economies. These include Hong Kong (Special Administrative Region), South

Korea, Taiwan (Province of China), and Singapore.Source: Bank of Canada

Projection for Global Economic Growth

Bank of Canada Liquidity Facilities Introduced Since 2007Q4

* This facility was replaced by the Term PRA for Private Sector Instruments on 16 March, 2009** In par-value terms

Announced

Weekly Amount Offered

Peak Amount

Outstanding** Eligible Securities Approved Counterparties

Term PRA 12 Dec 07$2 to 12 billion

$37 billion

SLF eligible: GOC securities, NHA-MBS, CMBs, other government guaranteed securities, provincial bonds, BAs, CP, ABCP, BDNs, corporate bonds, UST

Primary dealers and direct participants in the Large Value Transfer System

Term Loan Facility (TLF)

12 Nov 08 $2 billion $4.175 billionNon-mortgage loan portfolios

Direct participants in the Large Value Transfer System

Term PRA for Private Sector Money Market*

14 Oct 08 $1 billion $25 million BAs, BDNs, CP, ABCP

Primary dealers and federally / provincially regulated market participants who demonstrate significant activity in private money markets

Term PRA for Private Sector Instruments

23 Feb 09Minimum $1 billion

N/ABAs, BDNs, CP, ABCP and corporate bonds

Federally / provincially regulated market participants who demonstrate significant activity in private bond and/or money markets

Canadian Fiscal Stimulus