Bank of Canada Governor Mark Carney defended the central bank’s outlook on the economy and its ability to contend with the downturn before the House of Commons Standing Committee on Finance on Tuesday.

The bank has faced claims that it is being overly optimistic in its predictions that the global economy will grow by 1.1% this year followed by a 3.7% rebound in 2010; and, that it sees Canada’s GDP falling 1.2% this year and growing by 3.8% next year.

Some forecasts have the global economy actually contracting this year, and recovering at a much slower rate than the Bank of Canada predicts. Others see a slower recovery for Canada’s economy, too.

In his testimony, Carney allowed that the outlook for the global economy has deteriorated significantly in recent months. “What began last autumn as a relatively controlled slowdown has become a sudden, synchronized, and deep global recession,” he noted. He also stressed that the highly uncertain economic climate has led to widely divergent forecasts.

For Canada, Carney said that the first half of the year “will be particularly challenging with sharp falls in activity and increases in unemployment.”

“Unfortunately, last Friday’s employment report is broadly consistent with our outlook,” Carney added. “The 14% drop in our terms of trade since July will translate into a significant reduction in Canadian incomes and thus in our ability to sustain real domestic spending in the economy. Losses by Canadians on their financial holdings, either directly or via their pension funds, and concerns about the employment outlook will also restrain domestic consumption this year. Uncertainty about the economic outlook and strained financial conditions should lead to declines in investment spending this year.”

While the bank’s call for 3.8% growth in 2010 looks impressive, Carney stressed that “such a recovery is actually more muted than usual”. He said that the recovery should be supported by monetary policy, a relatively well-functioning financial system, the recent depreciation of the Canadian dollar, stimulative fiscal policy, a rebound in external demand particularly in emerging markets, stronger commodity prices, resilient Canadian balance sheets, and a housing market stabilization.

He noted that a wider output gap and modest decreases in housing prices should cause core consumer inflation to ease through 2009, bottoming out at 1.1% in the fourth quarter. Total CPI inflation is expected to dip below zero for two quarters in 2009, reflecting year-on-year drops in energy prices.

“The bank views the possibility of deflation in Canada as remote,” he said, adding that it sees inflation returning to its 2% target by 2011. It sees the significant upside and downside risks to the inflation projection as roughly balanced.

All of this is predicated on the successful stabilization of the global financial system, Carney allowed, stressing that this task “is far from complete”.

For its part, Carney noted that the Bank of Canada cut rates deeper and sooner than most other major central banks, and he insisted that the bank still has room to ease policy further if necessary, despite the fact that rates are already at a rock bottom 1%. Apart from adjusting overnight rates, he indicated that it could use other levers, such as its liquidity programs to add monetary stimulus if required. That said, he didn’t indicate whether further easing would be necessary, stressing that it has recently cut rates.

Moreover, he pointed out that the efforts of other policymakers will be essential to saving the financial system. “Decisions taken in the coming weeks in the United States and in other major economies to isolate toxic assets in order to create a core of ‘good’ banks will be critical,” he said.

Additionally, Carney said that the countries of the G-20 countries must act to improve domestic and international regulatory frameworks. “In this regard, measures to improve transparency and integrity, to implement a macro-prudential approach to regulation, and to adequately resource the IMF are vital,” he said. “If these national and multilateral measures are not timely, bold, and well-executed, Canada’s economic recovery will be both attenuated and delayed.”

“The reality is that the financial crisis and subsequent recession originated beyond our borders and the necessary triggers for a sustainable recovery must be found there as well,” he added.

IE