OECD Economic Outlook, Volume 2023 Issue 2

Canada

Real GDP growth will drop to 0.8% in 2024, reflecting slowing domestic demand in the wake of higher borrowing costs and weakening exports, before recovering to 1.9% in 2025 as improved global conditions strengthen exports. Immigration will continue to boost private spending and labour supply. Price pressures will ebb in the face of slowing demand and rising unemployment. Were unemployment to rise faster than expected, there could be a substantial fall off in households’ consumption demand and a deeper downturn.

The policy interest rate should be kept at its current level until inflation nears its target in 2024. Fiscal consolidation, partly due to the termination of cost-of-living relief, will also help cool the economy. Ensuring long-run fiscal sustainability while accommodating Canada’s multi-year spending pressures may require tax reforms and closer attention to spending efficiency. Further efforts to boost business productivity would expand the fiscal revenue base, alongside raising economic capacity and improving standards of living.

Output growth has stalled

Economic activity has slowed in recent months. Following a strong first quarter (real GDP grew by 0.6%), output growth stalled in the second quarter with effectively zero growth. Data suggest the weakness has continued. In July and August, estimated monthly GDP growth was weak, as were retail sales volumes. Headline inflation spiked up in recent months principally due to increasing fuel prices. Core inflation continues to decline and labour market tensions have eased. The rate of unemployment was 5.7% in October, half a percentage point above rates at the beginning of the year and the job vacancy rate has continued to fall. Nevertheless, by some metrics, the labour market remains tight compared with pre-pandemic norms. Wage growth has remained elevated in recent months.

Canada: Inflation and economic growth indicators

1. Per capita.

Source: OECD Economic Outlook 114 database; and Statistics Canada.

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Canada: Demand, output and prices

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Canada: Population and trade indicators

1. Total consumption and investment (including inventory variations) less total imports of goods and services. National accounts data do not disaggregate imports by expenditure component of GDP and intermediate inputs. In practice, imported value added forms part of consumption, investment and also exported goods and services.

Source: OECD Economic Outlook 114 database; and Statistics Canada.

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Despite increases in crude oil prices over recent months, Canadian commodity export prices remain below the peaks attained in mid-2022. The terms-of-trade decline has caused a negative income shock which is contributing to moderating demand. Yields of some key farm outputs, notably, wheat, are expected to decrease by 13.1% this year due to dry weather conditions. Extreme weather events, notably wildfires, have devastated a number of communities and caused disruption to some primary industries over the summer.

Excess demand is being contained by macroeconomic policies

Monetary policy remains contractionary, damping demand and helping re-anchor inflation expectations. The policy rate should remain high, at 5%, until mid-2024 to ensure price growth returns within the Bank of Canada’s target range of between 1% and 3%. However, macroeconomic conditions may evolve such that further rate rises are needed to quell inflation. As output moves closer to potential, the policy rate should be lowered towards more neutral levels. The projections envisage a 150‑basis point decline in the benchmark interest rate by the end of 2025. Gradual quantitative tightening is assumed to continue.

The fiscal stance remains restrictive, eroding the gross general government public debt burden which currently stands at around 100% of GDP. Weaker growth in nominal GDP and business profits will bring further declines in revenue growth. Federal and provincial measures cushioning households from living cost pressures have appropriately diminished. The federal government has not announced major new measures since bringing in a one-off tax credit for low-income households in March. Provinces have also wound down support. Reductions or suspensions of fuel taxation in Alberta and Ontario are scheduled to terminate by the end of this year. The federal government continues to follow through on structural reforms highlighted in its annual budget. These include supporting the green transition, expanding affordable childcare, accommodating the growing costs associated with population ageing and measures to lower the cost of housing.

High borrowing costs and subdued foreign demand will weigh on output

Real GDP growth is projected to drop to 0.8% in 2024. The slowdown in the US economy will damp exports. Capital spending plans will be dented by higher credit costs and a subdued demand outlook. Housing investment will return to growth, but only slowly. Continued rapid rates of population growth will help offset drags on private consumption from higher borrowing costs and weak real income growth. Economic growth will strengthen in 2025 to 1.9%, which is close to potential. Consumer spending will be supported by increased purchasing power. Stronger foreign demand will bolster exports and business investment. A further loosening of the labour market will see additional increases in the rate of unemployment until mid‑2024. Wage growth will moderate, remaining roughly in line with consumer-price inflation, which is projected to return to target by the third quarter of next year.

The outlook is surrounded by substantial risks. Labour markets could deteriorate more rapidly, increasing financial pressures on households, prompting cutbacks in consumption and raising difficulties in debt repayment. The high levels of immigration bring upside risks to private consumption along with potential for positive gains from newcomers’ skills and increased labour force participation. By expanding productive capacity, high immigration could enable stronger aggregate demand without significantly adding to price inflation.

Ensuring sustainable fiscal balances is key

Canada’s multi-year pressures on public spending represent a challenge for fiscal policy. For instance, over the next 15 years additional health and pension spending is estimated to total 2 percentage points of GDP. Maintaining a workable medium-term plan for lowering federal government debt would help ensure fiscal sustainability. As regards expenditure, ensuring cost-effective delivery on spending priorities will be important, including the expansion of affordable childcare. The effectiveness of measures to help households purchase homes should be kept under close watch, given the risk that such support pushes up the cost of housing. The policy focus should be on reducing excessive limits to supply in urban areas. As regards revenues, a shift towards more indirect taxation, including through higher rates of goods‑and‑services tax, should remain a policy objective. Canada’s long-run fiscal challenges would also be helped by policy to strengthen growth potential, notably through improvements to the business climate. The expected increase in female labour force participation from better access to affordable childcare will be beneficial for business, as well as households. Policy also needs to concentrate on measures that boost growth in business sector productivity, which has been lacklustre in recent years. Lowering barriers to inter-provincial trade in goods and services remains among the practicable steps that Canadian governments could take in this regard.