Monday, August 22, 2011

The private investment gambit

Finance Minister Jim Flaherty and Bank of Canada Governor Mark Carney gave public testimony to the House of Commons Finance committee on Canada's fiscal health. I am following these statements as it provides some indication on the methods the government will use to attempt to elicit economic growth in a low interest rate environment.

Scott Brison had some pointed questions for Carney, summarized by the CBC reporter through her live feed:
Carney noted austerity measures contributing to problems in Europe, Brison says, so will that happen here and what should we do? Carney says reducing spending is entirely appropriate. the private sector will need to sustain investment. we need to grow productivity. investment is strategic for governments to decide, carney says, sidestepping the question of where the government should invest.
This is the interesting situation Canada is in, in a nutshell. There is chronic high unemployment and a dearth of spending, in part due to reduced government spending -- austerity -- and reduced house price appreciation and tightened credit conditions due to high debt loads of households. Households are overextended and only servicing their debts by way of low interest rates. Meanwhile the private sector is "sitting" on cash and not investing for whatever reasons.

Public sector austerity coupled with a dearth of private consumption and investment is deflationary, as European countries are discovering. Carney is arguing Canada is different because the private sector can absorb decreases in public and household sector spending if given the right incentives to spend; if that fails to materialize the best alternative is would be increased government spending.

What does this say about future interest rates? I think the key statistic to watch is the unemployment rate dropping towards "full capacity", and we should be under no illusions that this may be several years away.

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