In many ways, the economies of the United States and Canada are similar. Both are seeing progress in the fight to control inflation. Both have solid employment levels.
But the U.S. economy is growing 4.9 percent, while ours has remained stable.
Economists warn that the figures do not even reflect the full extent of the differences.
“Things are actually worse than the data suggests,” said Royce Mendes, managing director at Desjardins Capital Markets.
He says explosive population growth has inflated economic growth in Canada. Without that, the economy would be decidedly worse than it is now.
So why are the Canadian and American economies performing so differently?
Two key factors are driving this. One is Canadian, the other is American. One is well known, the other surprised almost everyone.
The first is simple. Higher interest rates are having a disproportionately more severe impact in Canada than in the United States.
Canadians have higher debt loads. Those debt loads renew more quickly in Canada. That means higher borrowing costs hit harder and faster here.
Most Americans have a 30-year mortgage, so rising rates don’t have as big an impact as in Canada, where the average mortgage has a five-year term.
Americans spend more and save less
Millions of Canadian households are preparing to renovate in the coming years, so they will spend less and save more. In the United States, households spend more and save less.
“The United States is unique in the extent to which Americans are actually spending their excess savings,” Royce said. “Canadians continue to build on that savings pile because they know what will happen when it comes time to renew their mortgage.”
As a result, one economy advances while the other stagnates. Canada’s GDP has been in neutral for seven months.
But the way high interest rates are shaping behavior doesn’t fully explain the disparity between the two economies, says Bank of Montreal chief economist Douglas Porter.
He says the U.S. government has been spending big, introducing programs like the Bipartisan Infrastructure Deal, the CHIPS and Science Act, and the climate-focused Inflation Reduction Act.
The former deployed billions of dollars in spending to address decades of federal infrastructure delays, while the CHIPS Act provides billions of dollars in incentives to the U.S. semiconductor industry.
All of them are desperately needed. But they also represent trillions of dollars in new spending.
“I would call it a sugar rush,” Porter said. “Just a wave of U.S. fiscal spending that has actually led to the U.S. economy doing better this year than it did last year.”
National accounts data for both Canada and the United States were released in late October.
The numbers showed Canada’s budget picture was improving. The deficit narrowed slightly, to about $35 billion, or just over one percent of GDP.
“Fiscal strength will disappear in the United States”
In the United States, a very different picture emerged. Joe Biden’s administration posted a US budget deficit of $1.695 trillion in fiscal year 2023, a 23 percent increase from the previous year.
All that spending is helping to keep economic growth numbers higher than they normally would have been. Porter says the sugar rush won’t last.
“This fiscal strength will disappear in the United States,” he said. “It will actually become a drag over the next year, rather than contributing to growth.”
He says the Biden administration introduced those budget initiatives in hopes that the benefits of fiscal spending would still float through the economy when Americans go to the polls in 2024.
But many forecasts show that the US economy could begin to experience a slowdown as early as the fourth quarter of this year.
“They probably peaked too early on that front,” Porter said.
The diverging economic scenarios highlight the benefits and challenges for central banks on both sides of the border.
The burst in US GDP has some wondering whether the Federal Reserve will have to hold off on rate cuts, as it could make inflation even stiffer than it already is.
In Canada, some expect rate cuts to come sooner. Desjardins’ forecast now shows the Bank of Canada will cut rates in the second half of next year, with a rate of 3.5 per cent by the end of 2024 and up to 2.5 per cent the following year.
Start paddling in the same direction.
Last week, Bank of Canada Governor Tiff Macklem warned of the dangers of government spending that could boost economic growth but also slow progress in fighting inflation.
“It’s going to be easier to reduce inflation if monetary and fiscal policy go in the same direction,” Macklem told reporters.
Meanwhile, Jerome Powell, chair of the US Federal Reserve, announced the positive direction of the US economy as all that fiscal spending comes into play.
“Inflation has moderated since the middle of last year. The summer readings were quite favorable. But a few months of good data are just the beginning of what it will take to build confidence that inflation is coming down sustainably toward our goal,” Powell said. he said after the Federal Reserve announced it would leave rates unchanged.
But the divergence highlights political challenges.
The U.S. economy is posting big gains now, but will likely slow as the presidential election season heats up over the next year.
The Canadian economy is flirting with a recession now, but is expected to rebound next year, perhaps in time for a federal election that could take place in 2025.