IMF Concludes 2022 Article IV Consultation with Canada

Washington, DC : The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Canada.

Canada has come through the pandemic relatively well and, as a commodity exporter, has been hit less hard than many other countries have been by Russia’s war on Ukraine. Policymakers nonetheless face a difficult set of issues. High inflation has emerged as the principal near-term macroeconomic challenge in Canada, as it has globally. Housing affordability is a major concern following a long boom that may now have peaked. The pandemic remains a source of risk. And looking further ahead, climate change carries another critical set of challenges.

After contracting by 5.2 percent in 2020, real GDP bounced back by 4.5 percent in 2021 and continued to grow strongly in the first half of 2022. Labor markets tightened substantially, with the unemployment rate hitting a record low of 4.9 percent in June and July. And inflation surged to a 40-year high of 8.1 percent in June, propelled by rising commodity prices, supply-chain bottlenecks, the rapid domestic recovery, and the accompanying tightening of labor markets.

Both monetary and fiscal policies have been tightened substantially, triggering a welcome housing correction and a broader cooling of activity. But with the economy still in excess demand and inflation well above target at 6.9 percent in October, the policy rate will likely need to stay at or above 4 percent for most of 2023. Growth is expected to slow to 3.3 percent in 2022 and 1.5 percent in 2023. Unemployment should continue to rise moderately, reaching its pre-pandemic level of around 6 percent by next year, and inflation should continue declining, returning to the 2-percent target by end-2024. House prices are expected to retrace much of their pandemic run-up, falling 20 percent or more from peak to trough over the next few years, while the financial system is expected to remain resilient. Important risks, however, surround the baseline forecast, and shocks could easily push the economy into a mild recession.

Executive Board Assessment[2]

Executive Directors broadly agreed with the thrust of the staff appraisal. They welcomed Canada’s strong economic recovery from the COVID-19 shock but noted the challenges policymakers are facing, including from rising inflationary pressures, vulnerabilities in the housing market, and the global slowdown. Directors underscored that the key immediate priority is to bring inflation down without triggering a recession. Progress on necessary structural reforms, including to tackle climate change and promote the green transition, is also essential.

Directors concurred that fiscal policy should support the fight against inflation. They noted that support for households in the face of high fuel and food prices should be kept temporary and targeted and encouraged the authorities to save further revenue windfalls and consider accelerating deficit reduction from the next budget onward. Directors welcomed the federal government’s commitment to reduce the federal debt ratio and its publication of long-term fiscal projections. Many Directors were open to continued consideration of a specific debt anchor supported by an operational rule and to incorporate rules-based fiscal stimulus into the policy toolkit, but many others did not see a clear need for these measures.

Directors welcomed the Bank of Canada’s (BoC) decisive policy tightening. They agreed that the central bank should maintain a tight monetary stance to bring the inflation back to target and avoid de-anchoring of inflation expectations, and that it should continue clearly communicating its policy intentions. A number of Directors shared the BoC’s concern that the publication of the monetary policy rate path, as recommended by staff, could be incorrectly interpreted as a commitment.

Directors noted the ongoing housing correction triggered by policy tightening and agreed that the financial system would likely remain resilient. To durably address housing affordability, Directors emphasized the need for further policy measures, particularly to boost the supply of housing.

Directors welcomed progress toward implementing recommendations from the 2019 Financial Sector Assessment Program. They noted that there is scope to enhance some areas of financial regulation, including on crypto assets and AML/CFT issues, and to further strengthen interagency cooperation on financial oversight and address data gaps.

Directors commended Canada’s ambitious plans for reducing its currently high CO2 emissions. They agreed that any negative impacts on Canada’s competitiveness from countries’ differing policy approaches will need to be addressed and suggested that Canada is well placed to catalyze international agreement on a differentiated carbon price floor. Noting the importance of the oil and gas sector, Directors encouraged the authorities to develop a comprehensive strategy to help the economy and workers transition away from carbon-intensive products and processes.

It is recommended that the next Article IV consultation with Canada be held on a standard 12‑month cycle.