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Queen's professors forecast a brighter 2004
December 04, 2003
2003-12-04 - The 22nd annual Queen's Business Forecast 2004 was held in Kingston on Thursday, December 4, 2003. Professors John McHale (moderator), Marc Busch, Peggy Cunningham, Lynnette Purda, and Ajay Agrawal, from Queen’s School of Business, reviewed the 2003 forecasts and then presented their own views on the economy for 2004 and beyond. A summary of the panel’s forecasts for five major macroeconomic variables is included below. As an innovation this year, all attendees were surveyed on their views on current and prospective business conditions, and their responses aggregated to produce a Kingston Business Sentiment Index.
Each of the panelists considered the economy’s prospects from the perspective of their own particular expertise. John McHale reviewed the broad macroeconomic developments in 2003, emphasizing in particular how the economy evolved quite differently from what was expected due to a series of unforeseen shocks. Marc Busch focused on global economic issues, with an emphasis on current trade negotiations to open international markets. Peggy Cunningham examined Kingston economic development from a city marketing perspective. Lynnette Purda looked ahead to the likely evolution of key financial markets. And finally, Ajay Agrawal took a longer-term regional development perspective to reflect on Kingston’s broad development strategy.
Summary of Panel Forecasts for 2004
2003 proved to be a difficult year for the national, provincial, and local economies. Buffeted by a series of shocks—SARS, the electricity blackout, the mad cow scare, and a surging exchange rate prominent among them—real GDP growth between the third quarter of 2002 and the third quarter of 2003 was a disappointing 1.0 percent. Indeed, the economy actually contracted in the second quarter, and posted just a 1.1 percent growth rate (annualized) in the third.
There are some encouraging signs that growth is about to pick up. The poor third quarter performance was largely driven by reduced stock building by businesses, which should now have run its course. Final domestic demand grew strongly in the third quarter, and the final month of the quarter (September) posted a strong overall gain as economic activity got back to normal after the August electricity blackout in Ontario. Growth is also starting to pick up in Canada’s main export markets. On the negative side, exports have now contracted for four successive quarters—a first in twenty years. The 20 percent appreciation of the exchange rate vis-à-vis the U.S. dollar is obviously a major contributing factor(1). Overall, the panel is forecasting a substantial increase in real GDP growth rate from 1.0 percent to 3.1 percent(2).
With GDP growth averaging slightly above the economy’s long-run non-inflationary potential, the panel is forecasting a slight decline in the unemployment rate to 7.5 percent from the current 7.6 percent.
On the inflation front, 2003 was a year of two halves. Inflation rose strongly in the first half of the year, driven in particular by rising natural gas prices and insurance premiums. But in the second half, more stable energy prices, growing economic slack, and the effects of the rising exchange rate on import prices, caused the inflation rate to decline below the 2 percent mid-point of the Bank of Canada’s inflation-target band. With the likelihood of continued but diminishing slack in the economy, the panel is predicting a modest rise in the inflation rate to 1.9 percent from the current 1.6 percent.
The movements of the inflation rate largely explain the movements of the Bank of Canada’s overnight target interest rate (and with it the business prime rate). The central bank raised interest rates earlier in the year as their preferred inflation measure actually breached the 3 percent upper limit of the inflation-target band; but then lowered interest rates later in year as inflationary pressures eased. The Bank of Canada is now in a wait-and-see mode, and has kept the overnight rate target unchanged at its last two announcement dates(3). Although concerned by the rising slack in the economy and the uncompetitive exchange rate, officials clearly see signs of the economy rebounding on its own in response to strong domestic and foreign demand. Over the next year, the panel is forecasting a slight rise in the business prime interest rate to 4.7 percent from the current 4.5 percent.
Turning finally to the exchange rate, the panel—like all forecasters—finds it a tough call. The first thing to be said is that last year’s panel did not foresee the 20 percent appreciation against the U.S. dollar that occurred this year. The key question is: Has this appreciation further to go? On the affirmative side, it is noteworthy that the U.S. dollar is depreciating against all major currencies as international investors become less will to finance its massive half trillion dollar current account deficit. On the negative side, the likelihood of a falling Canada-U.S. interest rate differential should make Canadian assets relatively less attractive and put downward pressure on the exchange. Overall, the panel is forecasting a US$0.78 Canadian dollar exchange rate, a slight rise from today.
Notes:
1. This anemic growth performance this year contrasts sharply with surging U.S. economy—which grew by a staggering 8.2 growth rate (annualized) in the third quarter. Undoubtedly, this strong rebound was fueled by unsustainably accommodating fiscal and monetary policies. A comparison of the relative performances of the Canadian and U.S economies through the recent business cycle does raise concerns about Canada’s longer run relative productivity performance. U.S. companies responded to the downturn by freezing investment and hiring, but managed to improve productivity through ruthless cost cutting and outsourcing. Investment and employment held up better in Canada—with employment actually surging in 2002—but the economy seems less well competitively poised as we enter the expansion phase of the business cycle.
2. Growth is measured as the growth rate of real GDP between third quarter of 2003 and the third quarter of 2004.
3. The most recent announcement date was December 2nd.
For more information, please contact:
Dr. John McHale
Jmchale@business.queensu.ca
613.533.2832