Tuesday, 22 May 2012

Canada and US monetary policy - a Market Monetarist perspective

Market Monetarists maintain monetary policy should target nominal spending growth, not inflation.  They argue that had the Federal Reserve kept nominal spending at its pre-recession trend, the drop in real output would have been much less severe during the Great Recession.

Interest rates are used by most economists as a monetary policy indicator.  Market Monetarist argue that nominal GDP growth is a better monetary policy indicator. Nominal GDP growth above trend implies easy monetary policy, while below trend growth implies tight monetary policy.

Given the Market Monetarist perspective, what can we stay about the relative monetary stance between Canada and the United Stated?  Using data from the Bureau of Economic Analysis and Statistics Canada, the chart below compares NGDP from 2000 to the end of 2011 for both Canada and the US.  From 2000 to the end of 2006, NGDP growth was similar, averaging 5% annually, which is shown as the trend line.


After Q4-2006, NGDP growth in Canada began to grow above trend, while in the United States, growth continued at trend to about Q2-2008, at which point it began to fall below trend.  In  Q4-2008, Canada NGDP growth was almost 3% above trend, while US NGDP growth was about an equal amount below trend. By Q1-2009, both Canada and United Stated were below trend 3.2% and 6.8% respectively - we were in the Great Recession.

NGDP both in Canada and the United States bottomed in Q2-2009. How has NGDP growth and the relative monetary policy stance compared since?

From the graph below, NGDP growth has been much stronger in Canada since Q2-2009, growing at 6.1% annually.  This is above the 2000-2006 trend rate, implying a relatively easy monetary policy stance.  At this growth rate, Canada would regain its pre-recession trend level in 2018.  However, if the objective is to keep nominal spending at 5%, the current monetary stance may be too easy. For the United Stated, NGDP growth continues to be below trend since the bottom of the recession, implying monetary policy is too tight.

If the current trends in NGDP continue, implying a tighter monetary policy in the United States, the implications for Canada would be a higher relative inflation rate, and as well, a depreciating Canada dollar. 

No comments:

Post a Comment