Serious challenges and risks remain, but the Bank of Canada expects to see growth return this quarter, followed by a slow recovery into mid-2011.

In a speech to the Canadian Association for Business Economics in Kingston, Ont., on Tuesday, Timothy Lane, deputy governor of the Bank of Canada, noted that, “there are encouraging signs that we will return to positive growth this quarter.”

“Stimulative monetary and fiscal policies, improved financial conditions, firmer commodity prices, and a rebound in business and consumer confidence are spurring the growth of domestic demand. Globally, the vigorous policy actions taken by monetary and fiscal authorities appear to have reduced the probability of an extreme negative outcome for the global economy,” he noted. That said, Lane allowed that there remain significant upside and downside risks to the outlook.

The downside risks are largely external. “There is a possibility that financial conditions may normalize more slowly than expected, and further setbacks cannot be precluded,” he said. Moreover, much of the current demand is being driven by policy actions, which will have to be withdrawn at some point, and private demand will have to take over — managing that transition will be tricky.

Another important risk for Canada is the “possibility of persistent strength in the Canadian dollar”, which would weigh against recovery. “Other things being equal, a persistently strong Canadian dollar would reduce real growth and delay the return of inflation to target,” he said. “If a stronger dollar were to alter the path of projected inflation relative to that presented in our July Monetary Policy Report, we would need to take that into account.”

“As we have said before, even though we are at the effective lower bound for our policy rate, we retain considerable flexibility through the use of unconventional monetary policy instruments, including quantitative easing,” he added.

On the upside, there’s some risk that economic momentum could prove stronger and more sustained than expected, Lane noted. He said that Canada’s economic recovery will be supported by a combination of factors, including resurgent US demand, a stable financial system, and the underlying strength of household, business, and government balance sheets. “These favourable circumstances are expected to support the return to economic growth, with the output gap closing by mid-2011,” he said.

Looking further out, Lane noted that Canada faces a serious challenge, “that of continuing to improve our living standards against a less-favourable demographic backdrop.” This includes an aging population, slower growth in working age population, declining labour force participation, and a rising dependency ratio.

“Improved labour productivity is the key to meeting that challenge, and how we set about it will shape our economic well-being for years to come. Meeting the challenge will involve all Canadians: employees, business owners, researchers, policy-makers, inventors, and entrepreneurs. It will require creativity, adaptive learning, and innovation,” he said.

“The Bank has an important role to play. By achieving the inflation target, and by working to make the financial system more stable and efficient, it is contributing to the recovery that will take hold over the medium term. This work also helps to ensure that a sound foundation is in place for the work that must be done to meet the longer-term challenges that lie ahead,” he concluded.

IE