The global economy is slowing down as supply constraints, a war, sanctions against Russia and tension in the global trade environment are pushing up prices and interest rates. Uncertainty is pervasive, from the price of commodities to the effects of zero-COVID policy in China.
For the United States and Canada, that also have to cope with excess demand at home, there is a range of plausible scenarios for the next two years. Aside from external factors hard to predict, much depends on the response of wages and prices to the rapid tightening of monetary policy that both central banks begun in the first quarter of 2022.
Our assessment is that wages and prices are likely to respond fairly smoothly to the reductions in domestic demand caused by higher interest rates. Inflationary pressures thus should begin to abate early in 2023, and central banks should be able to halt policy interest rate increases at peak levels of 5.25% in the United States and 4.5% in Canada.
On this basis, our Baseline Scenario projects real output in the two economies to be basically flat in 2023. The United States would undergo a shallow recession in the first three quarters of the year. Canada should perform marginally better, advantaged by resource prices that are expected to remain relatively high, with oil prices in a range of US$70-85.
The two economies would be growing at a rate of about 2% during 2024. In both the United States and Canada, by the end of 2024, inflation should come down to close to the 2% target and the policy interest rate would drop to about 3%.
We think that our Baseline Scenario is a reasonable basis for planning by businesses. But there are risks. Mostly to the downside. For example, if prices are "stickier", and fail to respond enough to higher interest rates, central banks will need to tighten further and this will precipitate a recession in 2023 that could be pronounced, with knock-on effects, including on the fiscal position of governments.
This is why it is appropriate that central banks continue to affirm their strong intent to tame inflation and that governments complement monetary policy by moderating spending that adds to aggregate demand.
Risks have to be managed by businesses and governments not only day-to-day, but also in planning and executing a response to long-term trends and in capturing the upside of transformational change.
It bears repeating that three structural forces, and global responses thereto, will shape our economy and society now and over the next decades: climate change; innovation, notably digitalization; and demographic change, including ageing.
These forces are playing out in a geopolitical environment that is re-drawing global supply chains and placing a premium on security of supply of critical materials, including energy that Canada has in abundance.
Taking action to address these forces means investing: in physical capital, in innovation and intangible capital and in human capital. And in Canada, such investment must be at levels much higher than in recent years. We estimate a need for an added flow of public and private non-residential investment of some $80 billion per year.
Businesses and governments have to work together to capitalize on our assets, address gaps, grow our productive capacity and expand our ability to produce the goods and services that the world wants to buy. This requires a policy framework that, in an uncertain environment, supports confidence and incites private investment, while also strengthening global partnerships and market access.
The response to climate change requires investment of historic proportions in an energy transition, including electrification, while renewed attention worldwide to energy security also places Canada in a position to meet needs with reliable, responsible supply. To get things done, we need regulation that allows good projects to get approved and built on an accelerated timeline.
Digitalization is permeating all corners of the economy, from agriculture to health care or finance. Securing all of its benefits, while addressing privacy and security risks requires state-of-the-art infrastructure, sound regulatory and intellectual property frameworks, and government-business collaboration.
With population ageing and a steady stream of retirements come tight labour markets. Skilled immigrants—even as we raise their numbers— will not address all gaps. Businesses will have to raise output per worker faster by investing in productivity-enhancing capital and upgrading the skills of their workforce. Building the workforce for an economy in transformation must also be a priority of governments.
Despite the somewhat pervasive sentiment that the world is deglobalizing, Canada's interest is in greater international trade and investment, not less. While businesses and governments have to assess security of supply risks carefully, especially in the areas of advanced technology and critical materials, we have to aggressively pursue global opportunities wherever they present themselves. This includes our traditional markets like the United States and Europe, but clearly also the Indo-Pacific where intensified efforts are required to attract investors and to capitalize on expected strong demand growth in the next decades.
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