Speech by Bank of Canada Deputy Governor Timothy Lane

Brian DePratto, Senior Economist | 416-944-5069

Date Published: May 20, 2020

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For the BoC, COVID-19 Demand Hit Outweighs Supply Shock

  • Bank of Canada Deputy Governor Tim Lane delivered a speech today outlining the Bank's pandemic response, the uncertainty around the recovery, and the potential for long-lasting impacts.  
  • The Bank's response to COVID-19 is well known. The policy interest rate has been taken to the new lower bound of 0.25%, a slew of liquidity operations were announced and implemented, and the Bank of Canada has begun buying bonds and other debt with the goal of supporting government and other borrowing needs. All these actions are intended to support the continued functioning of the Canadian financial system (see our commentary for more on the Bank's recent Financial System Review), and increase the effectiveness of monetary policy. This ultimately supports the economy, particularly as government restrictions are eased and economic activity begins to normalize.
  • Like all of us, the Bank of Canada is grappling with the unprecedented uncertainty that the pandemic has brought – indeed, the Bank decided not to provide an economic forecast in its last Monetary Policy Report, opting instead for a range of scenarios. DG Lane found some reasons for optimism: the service sector has been hardest hit, but also tends to have high labour mobility (i.e. people switch jobs often). This suggests that rehiring could be relatively fast, helped by government programs. Conversely, Canada's export dependence, and the complex supply chains underlying it mean that firms may have challenges with suppliers or demand if other countries are at different stages of recovery. 
  • Similar to our analysis, Deputy Governor Lane expects the economic recovery to vary by industry. Some, like air and passenger travel, are seen as having a long time to recovery, and a large decline in production, while others, such as construction, are expected to come back relatively quickly, and to have lost relatively less production. The energy sector was singled out for analysis, although Mr. Lane noted that the challenges facing the sector do not have as much impact for Canada as a whole given the relative importance of oil and gas has fallen markedly since 2014. That said, he notes that "the pain is being deeply felt in the West".
  • Most interesting in today's remarks are those on the long-term outlook. Some sectoral changes may turn out to be permanent in nature: energy and travel could face weaker growth prospects for some time to come, while the ramp up in e-commerce and remote work could be to a permanently higher level/growth path. Global trade may also see change. Protectionist policies could accelerate shifts in cross-border supply chains. Bank of Canada consultations suggest that some firms are expecting the opportunities created by a return to domestic manufacturing to persist. This could translate to smaller, but more diversified supply chains, and increased production of health products domestically. This of course also implies a loss of access to some markets, and higher prices for goods and services.
  • The speech concluded with a discussion of the Bank's core mandate: the two percent inflation target. With all the moving parts at present, uncertainty around the inflation outlook is elevated. Economic scarring could mean lower productivity, and thus higher inflation. But the huge shock to demand works in the opposite direction. On balance, the Bank of Canada sees the risks to inflation as skewed to the downside. Thus taking the policy interest to 0.25% and the introduction of market operations to transmit policy to the real economy.  

Key Implications

  • We're all in 'wait and see' mode right now as governments begin to move from pure curve flattening to cautious re-opening. But uncertainty abounds. Will consumers go back to the shops just because they're open? Will post-pandemic jobs match the skills of those currently laid off? How long can firms in high-risk sectors hold out for with near-zero revenue?   
  • No-one has these answers, but the Bank of Canada today shared some of its thinking. An uneven recovery seems to be the order of the day. But perhaps more importantly given the Bank's inflation control target is the thinking on supply and demand balances. The Bank appears to be relatively optimistic on supply, suggesting that many currently unemployed Canadians may be able to find work relatively easily. The bigger concern appears to be the shock to demand as household incomes and wealth have taken significant hits.  
  • Less demand means less inflation, and thus the core of the Bank's recent unprecedented actions, both in interest rate cuts and asset purchases. With the effects of the pandemic likely to linger for some time, so too will low rates and other extraordinary monetary policy measures.