OECD Economic Outlook, Volume 2024 Issue 1

Canada

Real GDP growth will pick up from 1% in 2024 to 1.8% in 2025, reflecting strengthening global conditions, the boost to private spending and labour supply from immigration, and monetary policy easing. Growth will nevertheless remain below trend, and price pressures will ease. Price inflation has already declined to the upper boundary of the target band. Developments in the housing market and related debt still require close monitoring.

Monetary policy should remain restrictive but a start to policy rate cuts is expected in the coming months. Growth in government outlays will slow progress in strengthening fiscal buffers. Long‑term fiscal sustainability requires tax reforms and close attention to spending efficiency to accommodate emerging spending pressures. Canada’s weak productivity performance in recent years underscores the need for a more growth-friendly tax mix, including removal of internal trade barriers, measures to facilitate employment (including through more childcare services) and efficient but effective policy on green transition.

Growth in economic activity has started to recover

The economy barely grew in the second half of 2023 (real GDP shrank by 0.1% in the third quarter and increased by only 0.2% in the fourth). Business investment was particularly weak, shrinking by 7.7% in the final quarter of 2023. However, monthly industry GDP estimates point to strong growth in January and February, partly reflecting the end of a public-sector workers’ strike in Quebec. Household consumption growth has started to pick up, and export volume growth was strong at the end of 2023. Price inflation continues to decline. In March, annual headline consumer price inflation was 2.9%, just within the upper bound of the central bank’s target range. Shelter price increases remain elevated, contributing to inflationary pressures. Measures of core inflation are close to 3%. The unemployment rate notched up to 6.1% in March. Employment continues to grow more slowly than the population. The latter is being driven up by large temporary and permanent inflows. In the year to the fourth quarter of 2023, Canada’s population increased by 3.2%, the highest rate of growth since the 1950s.

Canada: Inflation and economic growth indicators

1. Per capita.

Source: OECD Economic Outlook 115 database; and Statistics Canada.

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Canada: Demand, output and prices

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Canada’s trade developments continue to echo shifts in global conditions. In February, the value of merchandise exports rose by 5.8% (month on month) and imports by 4.6%. However, it is too early to tell whether this reflects the start of a trend improvement in trade growth.

Canada: Population and economic growth 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 115 database; and Statistics Canada.

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Less contractionary monetary policy is on the horizon

Contractionary monetary policy has damped demand and is helping anchor inflation expectations. Headline consumer price inflation is now within the target range. Conditional on the more persistent elements of inflation receding, reductions in the policy rate are expected over the course of the year. The projections envisage a total 150 basis-point decline in the benchmark interest rate by the end of 2025. Gradual quantitative tightening is assumed to continue.

Following the unwinding of large deficits in the wake of the pandemic, the general government fiscal balance slipped from a small surplus in 2022 to a minor deficit in 2023. In 2024, the general government fiscal deficit is expected to widen slightly, owing in part to higher spending. The budget balance is expected to improve only modestly over the remainder of the projection period. The federal government continues to follow through on the structural reforms highlighted in its latest annual budget. These include measures supporting the green transition, expanding affordable childcare, accommodating the growing costs associated with population ageing, and improving housing affordability. Increased government outlays are being partially offset by spending efficiency measures and plans for higher taxes, including on capital gains.

Output growth will strengthen

Real GDP growth is projected at 1% in 2024. Consumption will gather momentum over the year and into 2025 with increases in purchasing power. Continued rapid population growth will help support output growth. Economic growth will strengthen to 1.8% in 2025. Stronger foreign demand will bolster exports and business investment. There will be some further loosening of the labour market in the first half of 2024. Wage growth will moderate, remaining roughly in line with consumer price inflation. Headline inflation is projected to be close to the centre of the central bank’s target band by the third quarter of next year with core inflation slightly higher.

The risk profile of the outlook has shifted in recent months. The risk of sustained high inflation has diminished. Higher borrowing costs could have a more profound impact on consumer spending and investment decisions than expected, adding uncertainty to the near‑term outlook. Developments in housing debt and related financial stress among households need to be monitored carefully. Meanwhile, high levels of immigration are helping relieve skill shortages and bring upside risks for private consumption, while also increasing strains on housing markets.

Bolstering productive capacity and achieving climate targets

Canada’s absence of sustained labour productivity growth in recent years underscores a need to ensure a policy environment that enables the business sector to become more efficient and to move up value-added chains through increasingly productive activities. Increases in output per worker would in time feed through into higher average wages and household incomes. A stable macroeconomic environment is an important ingredient, including well-anchored inflation and sustainable fiscal balances. Fiscal sustainability requires implementing credible medium-term plans for lowering federal government debt, aided by ongoing measures to improve spending efficiency. Tax reforms should include reconsideration of preferential rates of tax for small businesses, which may affect small firms’ productivity growth and distort the allocation of resources across different types of firms. In addition, shifting to a more growth‑friendly tax mix by increasing revenues from consumption taxation should be considered. The total revenue share of federal and provincial value-added/goods and services taxation is low in international comparison. Canada’s internal trade barriers should remain on the structural reform agenda as these likely have large economic costs. Canada will require strong incentives for abatement to achieve its climate targets. Multiple policies are in place to decarbonise economic activity. Efforts to tighten carbon pricing rules should continue alongside the scheduled increases in the carbon price floor. The federal government’s decision in late 2023 to exempt home heating oil from the carbon tax marks a step away from consistent pricing. Subsidies can spur green technology take-up but should be reined in as cost‑effective products emerge. Reform of electricity pricing could encourage energy saving with less need for additional government intervention.