I have been observing Canadian economic developments for nearly a half a century. Never has forecasting required a host of exogenous assumptions regarding non-economic factors, all related to the management of the Covid-19 health crisis.

So, at best, let me describe the impact of COVID-19 on the economy to date and just how large and deep is the economic hole in which we find ourselves. Knowing the size of the problem is a necessary condition to anticipating how great the task before us is.

How Deep is the Hole? 

A series of charts depict the extent of the collapse of the Canadian economy starting in the early Spring 2020. The service sector clearly was the hardest hit, dropping to 60% compared to the pre-COVID-19 level, while the rest of the economy contracted by 10% approximately (Figure 1).

While there has been some modest recovery in the first quarter of 2021, subsequent lockdowns in Ontario, Quebec, and B.C. will negatively hurt the second quarter. While the lockdowns remain in place, all we can do is to speculate on the outlook for the balance of the year.   

Figure 1.

Although there has been an improvement in the unemployment rate, approximately 300,000 additional people would need to be hired just to reach the pre-COVID-19 employment level. Given the normal rate of growth in the labor force, the economy needs to generate, in total, 475,000 jobs this year.

Thankfully, the unemployment rate has declined from its peak of 13.7% in May 2020 to 7.5 % in March 2021. Despite this improvement, the share of unemployed people who have been without a job for 27 weeks or more remains elevated, at about 30 %. This is particularly disconcerting because long periods of unemployment have been associated with a lower attachment to the labor market and an overall weakening of the economy. 

Despite the strong estimated growth in the first quarter of 2021, considerable excess supply still exists. At the depth of the shutdown, the Canadian recession fell by 12% in early 2020. The rebound since still leaves considerable unused capacity. Estimates of the shortfall or the output gap - the difference between actual and potential economic performance - is in the range of minus 3-6%, which is consistent with the current high unemployment rate.

This shortfall is all the more worrisome given that our potential growth rate has already been eroded and is estimated to be around 1.5% annually (Figure 2). Moreover, even the most optimistic outlook for a recovery anticipates that the gap or shortfall will not be eliminated in less than two years.

Figure 2.

How Much of the Hole Was Filled by Government Stimulus?

The Canadian Government stepped into the breach, provided direct cash transfer to workers as well as a host of loans and grants to businesses facing serious layoffs or business closures. Some additional $85 -$100 billion will be pumped into the economy through unemployment insurance and specific relief programs by the end of 2021. This amount represents about 5-7% of Canadian GDP, but is considerably smaller than the US stimulus package equal to 10-12% of GDP.

The Federal government anticipates that the employment insurance payouts return to their historical levels in the 2022-2023 budget. More significantly, the special relief programs are likely to be phased out by late 2021 and eliminated in 2022. The great unknown is whether the economy will be functioning normally by the end of 2021 without any further government transfer payments. So much rests on a positive response to that question.

Figure 3: Federal Transfer Payments. Source: Finance Canada, Budget, April, 2021

What Will Hold Back a Full Recovery?

Historically, recessions have a conventional pattern. Monetary policy eases, promoting spending by consumers and business. Adjustments are made to inventories and production and, in general, recoveries experience a boost in consumption or its counterpart a reduction in the savings rate. Can we expect a similar pattern as the rebound from the pandemic takes hold?

The Bank of Canada raises some very troubling issues in commenting on how consumer behavior may well change permanently, to wit:

The Bank continues to assume that households will choose not to spend these savings on goods and services but instead use them to pay down debt, buy homes or invest. In addition, a heightened demand for precautionary savings is assumed to persist for some time. 

Prolonged labor market adjustment may contribute to cautiousness on the part of some consumers, including a demand for precautionary savings. It may take a long time for some businesses in severely affected sectors to recover and rehire workers.”

In other words, we will not be the same as we were prior to the pandemic. Rightly so, we can expect a whole set of behavioral changes in consumption and savings patterns long after the all-clear sign is given regarding the end of the pandemic.