Remarks to the Halifax Chamber of Commerce

March 18, 2014

The global economy may not be just suffering through a hangover from the financial crisis. There are other, longer-term forces at work as well. Some analysts are suggesting we may be facing a long period of secular stagnation. On this alternative view, the economy could perform well below normal, leaving many out of work or underemployed for a long time to come. As business people, you need to understand that possibility, and how much weight to put on it. As a central banker, I need to understand it as well.

Let’s dive in. Long-term economic growth is driven by two factors: 1) growth in the supply of labour, which is connected to population growth and changes in its composition, or what we call “demographics”; and 2) productivity growth, which is economists’ shorthand for how efficiently we produce goods and services…

Productivity growth fluctuates around a long-term trend, tending to be weak during recessions and the early stages of a recovery, and stronger in periods of economic expansion. It follows then that the weakness in productivity growth since the financial crisis may be a symptom of a post-crisis hangover. Indeed, in Canada, the latest data show a pickup in productivity in the second half of 2013, to around 2 per cent, which is very promising. The Bank’s outlook for the next couple of years is that uncertainty will continue to dissipate, boosting investment and new firm creation, and then productivity growth is expected to outpace its 30-year average.

The other ingredient of Canada’s potential economic growth is the labour force. So let’s turn to demographics and start with one immovable fact and one quick reminder. First, we are all getting older each day; and second, the baby-boom generation — yes, I am among them — is Canada’s largest population cohort.

The demographics story is often told as one about the labour force: as the boomer generation retires and exits from the workforce, labour’s contribution to the potential growth of the economy declines. This is already under way. In 2011, the growth rate of the population of working-age Canadians crossed below that of the overall population, reversing an almost 50-year trend. The Bank expects that next year, labour’s contribution to the potential growth of the economy will be half what it was in 2007. That’s the labour story, in a nutshell, and it is slowing us down.

There’s another dimension to the demographics story — one that gets less attention, but that merits careful consideration to fully understand what the future holds.

As people move through different stages of life, their spending and savings habits change. Think of the students out there who are amassing university or college loans. A bit later on, people enter a family-building stage, which normally involves some heavy borrowing up front for a family home. As we get older, we tend to take a breather on the accumulation of debt; we work at paying it back and start to put aside savings.  As we get closer to retirement, people save more and build up wealth. Typically, in the 15 or 20 or so years before they retire, people are in serious nest-building mode.

As the facts show it, Canadian households are indeed getting wealthier, which is a good thing. Data released last month show that, despite the financial crisis and Great Recession, net worth rose noticeably across all age groups from 1999 through 2012.

Now, let’s bring the boomers into the picture. They’re called the boomers for a reason. The huge wave of that generation simply overwhelms the charts. Born between 1946 and 1964, the youngest boomers are turning 50 this year. And so, right now, we are seeing a very predictable demographic bulge of more people, putting away more savings. This is Mother Nature at work, and it’s where things get interesting.

Why does a central banker care? First, the financial decisions made by individuals are of course important to those individuals. But when a large swath of the population is making similar decisions, the impact on the broader economy can be significant. Second, where individuals decide to store their wealth also matters a great deal.

Canadians, it won’t surprise you, love their houses. We hold a lot of our wealth in real estate. This practice preceded the crisis, and it was reinforced by it. You may recall — it even may have been your experience — in the 1990s, the share of household wealth in financial assets, such as equities, was increasing faster than that in real estate.

But since then, real estate has become more attractive and has grown as a share of total household assets. With the ”dot-com” bust and Enron and other corporate scandals in the rear-view mirror, with low interest rates helping keep mortgage payments manageable, and with cocooning taking hold, housing was increasingly seen as a safe and attractive investment. For the sector as a whole, real estate assets accounted for 40 per cent of total wealth in 2012, up quite a bit from 32 per cent in 1999.

Economists have their own way of interpreting these trends. We see some forms of assets primarily as “stores of value,” while others work through the system to fund investments and add to the productive potential of the economy. Savings that fund infrastructure and business investment are “being put to work,” which can help improve productivity, while savings that go into housing are seen as contributing less to productive potential.

This shift toward housing was also evident in many developed countries before the crisis hit and could have contributed to a slower growth rate for productivity…

In Canada, low policy rates motivated Canadians to invest even more in real estate. You could say the Canadian recovery was due to the reinforcing of activity that was already under way, thanks to underlying demographic forces.

But we know that we cannot sustain economic growth in Canada based on housing alone. Our belief is that the post-crisis hangover in the United States is dissipating, and momentum is building. This will inevitably lead to more growth in Canadian exports and, with the reduction in uncertainty that comes with that, more investment in Canada’s economic capacity, including creating more companies — and the much-anticipated rotation in growth…

In the broader global economy, however, the possibility of secular stagnation needs to be taken seriously. The combination of low demand, low investment and high savings could be having an impact on what economists refer to as the Wicksellian rate, or the equilibrium real rate of interest. There is rigorous theory behind this notion, which I will spare you, but it suggests that interest rates may remain lower than we have experienced in the past for a longer period, until some of these long-term forces dissipate. One specific consequence would be that even extraordinarily low policy interest rates could prove to be less stimulative than in normal circumstances…

Over 40 years ago, the Club of Rome published a book entitled The Limits to Growth. To the global think tank, those limits were about finite natural resources and the environment. Although the timing remains uncertain, its arguments remain relevant today…

We continue to believe that the world economy is healing, and that Canada will benefit in the form of stronger exports. From there, we expect to see more investment and new firm creation. This will permit the emergence of a natural, sustained growth trajectory for Canada, and a return of inflation to our 2 per cent target.

But the demographic forces that are in play suggest that the growth trajectory that we converge on after the recovery period will be slower than our historical trend.