Economy's Plan B is more stimulus: CIBC

A CIBC sign sits in Toronto's financial district on Feb. 26, 2009. THE CANADIAN PRESS/Nathan Denette

OTTAWA - The economic clouds gathering beyond Canada's borders are so ominous that at least two bank economists recommend Canadian governments, and particularly Ottawa, start thinking about a contingency plan should the world be plunged into a second crisis — further stimulus spending.

CIBC chief economist Avery Shenfeld, who cautions that another recession is not in his baseline forecast as yet, believes Canada's best response to a new crisis should not be for the Bank of Canada to cut interest rates further.

That would merely stimulate an already overheated housing market and lure even more households to take on debt that is already at record levels.

Rather, Shenfeld recommends that the federal government do the borrowing and use the money for a second round of stimulus spending, on needed infrastructure such as roads and power projects that will serve the economy well into the future.

Ottawa is well-placed for a second round of deficit-spending because its books are relatively sound, and could borrow at very low rates. He says the government could actually wind up richer rather than poorer by borrowing now.

"Ten-year rates have been below two per cent, and if you take on inflation, the economy might be growing long term at something like four per cent in nominal terms," he explained.

"So if you can create some additional room for economic activity because you've built things the economy needs, it could pay off in future tax revenue flows that pay the interest."

The Canadian economy is broadly expected to keep growing at about two per cent in the current year, and in 2013, a weaker recovery than earlier predicted but still well north of actual contraction.

Canada appears set to print an against-the-grain month of healthy growth for May in fresh data set for release Tuesday. But even on the island that so far has been Canada's economy, May's gross domestic product report from Statistics Canada isn't likely to change economists' minds about where they economy is headed.

The consensus among analysts is that the data will show a gain of 0.2 per cent, with some analysts thinking it will be as high as 0.3 per cent, matching the strongest monthly tallies since last July.

Shenfeld says May's performance won't likely be repeated in June — or the next few months afterwards — given troubling signals from around the world, and especially Europe.

"As Europe struggles through a recession and America's economy continues to disappoint, markets are focused on the downside risks ... so much so, that for some weeks, a small interest rate cut was priced into Canada's yield curve," he writes in a new paper titled "Canada's Plan B."

Shenfeld said he is not recommending Ottawa bring in stimulus now, although he thinks it would be a good idea for the United States.

"The U.S. has a huge reservoir of unemployed construction workers, and by putting them back to work, the government would actually generate additional tax revenues and economic growth that could cover the future costs (of borrowing)."

It's not every day that bank economists argue the benefits of government intervention in the economy, especially on borrowed money. But Shenfeld's thesis gets some support from Doug Porter of the Bank of Montreal as well.

Like Shenfeld, BMO's deputy chief economist says Ottawa should not push the panic button on a second round of stimulus until it is needed, although given the lag time in getting useful infrastructure projects going, it would be wise to draw up contingency plans.

Speculation around global recession has mounted as Europe's problems look more and more intractable.

"I think something did shift for a lot of economists sometime late last year and early this year," Porter explained.

"A lot of people got a lot more concerned about the medium term realizing that Europe had years and years of challenge ahead of it, and the U.S. is also unlikely to break free with strong growth."

In fact, the U.S., which was expected to outperform Canada in growth this year, is being sideswiped by Europe to an ever greater degree than its northern neighbour. It has already reported an anemic 1.5-per-cent annualized growth rate for the second quarter, while Canada is expected to hit near two per cent in the April-June period.

Still, the longer-term prospects for Canada appear to be muted growth at best. Apart from Europe, the domestic economy is being weighed down by heavy consumer debt, which dampens spending, and weak exports.

That leaves business investment to do the heavy lifting.

But although firms are flush with cash, capital investment on such things as machinery and equipment is not a big enough part of the economy to sustain a strong recovery, noted David Madani, chief economist with Capital Economics.

"All things considered, we forecast business investment growth of about 4.5 per cent in 2012 and close to four per cent in 2013," he said. "Unfortunately, this growth is only enough to buffer the anticipated slowdown."

The enthusiasm over the May report being released in Ottawa at 8:30 a.m. Tuesday is based on previously reported indicators, including positive readings for sales, manufacturing and wholesale trade. As well, hours worked grew during the month, a strong signal of increased output.

The possible wild card in the expectation, said Scotiabank economist Derek Holt, is the possibility of soft energy sector activity due to ongoing production disruptions.