Memorandum

Subject:

Transition Briefing Overview

For information

This information note is intended to provide you with the information and context required to evaluate and plan the scope of your work over the coming weeks. The note includes:

• *redacted* Economic and fiscal outlook; and,
• *redacted* the Government's key election platform commitments.

In addition, a full description of the Department, your statutory responsibilities and authorities, and the organizations in your portfolio is included in a separate briefing binder ("How the Department of Finance Works") as a reference manual for you or any new incoming staff in your office.

1. Economic and Fiscal Outlook

i. Economic Context and Challenges

Since mid-2018, there has been a widespread slowdown in global economic activity. New tariffs, and heightened uncertainty surrounding trade and geopolitical developments have reduced business investment and manufacturing output in key trading economies. This is dampening global economic activity despite recent moves by most central banks towards a more accommodative policy stance.

• In the U.S., growth is gradually slowing to a more normal pace following a few years of stimulus-fueled activity. Labour markets are holding up quite well and consumer spending remains solid. However, more trade sensitive parts of the economy, notably the industrial sector, are easing despite massive tax cuts, raising concerns that as time passes this unresolved weakness may spill over into the wider economy.
• Economic growth in China is also decelerating to its slowest pace since at least 1992 (when official records for quarterly growth started) as the country is dealing with the negative impacts from deepening trade tensions with the U.S. and going through needed deleveraging and regulatory reforms.
• Meanwhile, in Europe, economic activity is slowing more significantly as the region is grasping with a sharp industrial slowdown, particularly affecting Germany, and uncertainty around the timing and form of the potential exit of the U.K. from the European Union.

Moreover, there are fundamental shifts taking place globally, which may have longer lasting, if less immediate, impacts on future global economic growth:

• New tariffs and global trade tensions, notably but not exclusively between the U.S. and China, have likely started a reconfiguration of global value chains. A protracted and wide-ranging trade dispute would raise the producing and trading costs of goods and services, reducing long run global economic growth.
• Demographic changes as a result of population aging also mean that there will be fewer workers in the future. Economic growth will thus be slower unless the productive capacity of economies is improved.
• New economically disruptive technologies, including big data, could transform the way we live and work by changing production processes, challenging prevailing business models, and creating new products, markets, as well as risks.  Harnessing these changes will be critical to benefit from the promised productivity boost that is expected to come with these new technologies.

These long-term economic and geopolitical trends will have important implications for Canada's ability to continue to increase living standards. Canada also faces more specific challenges. The global transition to a low-carbon economy will have a particular impact on our energy sector. Our high level of household indebtedness also makes our economy more vulnerable to external shocks and may constrain future monetary policy actions.  

The Department's analysis of economic developments and public opinion research lead us to conclude that, despite ongoing wage growth, these developments and the associated challenging global economic and geopolitical backdrop more generally, have created a sense of anxiety that Canadians are feeling about their economic prospects. Many of the Government's platform commitments are directed at addressing these concerns. Maintaining Canada's economic advantages and succeeding in this challenging global environment will, however, require a focus on medium-term growth-oriented policies targeted at:

• improving Canada's competitiveness;
• ensuring full utilization of the Canadian labour force, and;
• making the investments required for effective transition to a more digital and low-carbon economy.

*Paragraph redacted*.

ii. Canadian Economic Outlook

Over the past three years, the Canadian economy has held up quite well in an environment of slowing global growth and rising trade uncertainty. The labour market remains strong, with historically low unemployment rates and high labour force participation rates. On average over the last year, 40,000 new jobs have been created each month, twice the pace registered over the previous five years.

Wage growth has picked up to close to 3 per cent, reflecting the increasing tightness of the Canadian labour market. This is a welcome development as wage growth has been weak since the recession of 2008-09. According to some measures nominal wage growth in the past 3-months has picked-up to its fastest pace since 2009 and well above the general rise in prices. Given the strong pace of job creation, we expect that this pick-up in wages should translate into healthy income gains for Canadian households in the near term. Whether or not this trend is maintained will largely depend on the extent to which the global economic slowdown affects Canadian output and labour demand.

Housing markets were soft in 2018, reflecting the combined impacts of previous increases in interest rates, provincial policies to deter unproductive housing activity and federal policies to reduce household indebtedness. However, housing activity has been rebounding in recent months, due in part to recent declines in interest rates back to the low levels seen in 2015-2017. Price growth has picked up in Toronto to 10 per cent (3-month change, annualized), while in Vancouver prices have started to rise again following declines since spring 2018.  

The Department continues to monitor three major concerns with the Canadian economy:

• In the context of heightened global uncertainty, business investment has struggled to make gains over the last year. Ongoing adjustments in the oil and gas sector have weighed on business investment significantly since 2015, when global oil prices fell from around US$100 per barrel to around US$50 per barrel. Prior to this shock, investment in Canada's oil and gas sector had represented about 30 per cent of total business investment. Today that share has been reduced by more than half and continues to decline. As a result, Canada has tended to lag other major advanced economies when it comes to growth in business investment.
• In recent years, modest increases in total real exports have been driven in large part by exports of energy commodities and services. Meanwhile, real exports of non-energy goods have remained largely unchanged for more than a decade. Canada has been losing market share in the U.S., our most important export destination, along with intensification of competition within that market. *Sentence redacted*
• The high level of household indebtedness remains a key vulnerability for the Canadian economy. A negative shock to Canadian incomes or house prices could put a strain on household finances and hold back consumption and residential investment for a prolonged period of time.

After a strong rebound in the second quarter of 2019, recent data suggest that economic growth in Canada will return to a more moderate pace closer to the potential growth rate of the economy in the second half of 2019, between 1 ½ and 2 per cent.  

The Department regularly surveys private sector forecasters for their views on major economic variables such as GDP, consumer price inflation, the unemployment rate and interest rates, generally following each release of the quarterly National Accounts (GDP) data. Since 1994, the average of these private sector forecasts forms the basis for the economic assumptions used for fiscal planning in the budget and Fall Update. This practice has been strongly supported by external organizations such as the International Monetary Fund.

The Department surveyed the group of private sector economists in September, following the release of the National Accounts second quarter results for 2019.  The September survey data are typically used to support the government's economic and fiscal projections published in the Fall Update. Overall, the projected level of nominal GDP (the broadest single measure of the tax base) in the September survey is in line with the Budget 2019 projections (Table 1).

• Real GDP is projected to grow at a rate of 1.7% over the five-year forecast horizon, similar to projections in Budget 2019;
• The outlook for oil prices is to average US$57 in 2019 and US$59 over the forecast horizon;
• Notably, both short and, particularly, long-term interest rates were significantly revised down across the forecast horizon, compared to Budget 2019. Over the past six months many central banks around the world have shifted to a more accommodative policy stance. This has resulted in lower expectations for interest rates going forward. In Canada, financial markets are pricing in some chance of a rate cut by early 2020. Meanwhile, long-term interest rates have also seen declines on a combination of revised expectations for monetary policy as well as renewed trade tensions.

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