Unpacking why the US economy is outpacing Canada's growth

06 Nov, 2023

Unpacking why the US economy is outpacing Canada's growth

In many ways, the economies of the United States and Canada share similarities. Both countries have made strides in combatting inflation and maintain healthy employment levels. However, there's a stark contrast in economic growth, with the US flourishing at a rate of 4.9 percent while Canada's economy remains stagnant.

Economists warn that the data doesn't fully capture the extent of these differences. According to Royce Mendes, managing director at Desjardins Capital Markets, explosive population growth has artificially boosted Canada's economic growth. Without this factor, Canada's economic situation would be significantly bleaker.

Two key factors explain the discrepancy between the two economies, one Canadian and one American. One is widely recognized, while the other took many by surprise.

Firstly, higher interest rates are impacting Canada more severely than the United States. Canadians carry higher debt loads, and these debts renew more frequently in Canada, leading to increased borrowing costs. In contrast, most Americans have 30-year mortgages, which are less sensitive to rising interest rates.

As a result, many Canadian households brace for mortgage renewals in the coming years, prompting reduced spending and increased savings. Meanwhile, American households are spending more and saving less. This behavior divergence contributes to the differences in economic performance.

Nevertheless, high interest rates alone do not completely elucidate the economic gap. Douglas Porter, the chief economist of the Bank of Montreal, highlights the significant role of US government spending. Initiatives such as the Bipartisan Infrastructure Deal, the CHIPS and Science Act, and the climate-focused Inflation Reduction Act have poured billions into addressing infrastructure backlogs and supporting the semiconductor industry.

Porter describes this phenomenon as a "sugar rush" that has boosted the US economy this year. In contrast, Canada's GDP has remained stagnant for seven months.

The release of national accounts data in both countries revealed contrasting fiscal pictures. Canada's deficit slightly shrank to about $35 billion, while the US budget deficit soared to $1.695 trillion, a 23 percent increase from the previous year.

This massive spending contributes to sustaining higher economic growth numbers, but Porter warns that this fiscal boost in the US won't last. It might even become a drag on the economy in the near future. The Biden administration introduced these initiatives with the hope that the fiscal benefits would still be present when Americans go to the polls in 2024. However, forecasts indicate a possible slowdown as early as the fourth quarter of this year.

The divergent economic scenarios pose both advantages and challenges for central banks in the US and Canada. In the US, the surge in GDP raises questions about the Federal Reserve's ability to implement rate cuts without exacerbating inflation.

Conversely, some expect rate cuts in Canada to come sooner. Desjardins's forecast suggests the Bank of Canada might cut rates in the second half of next year, with a rate of 3.5 percent by the end of 2024 and further reductions to 2.5 percent the following year.

Bank of Canada governor Tiff Macklem has warned against government spending that could stimulate economic growth but hinder the fight against inflation. In contrast, Jerome Powell, chair of the US Federal Reserve, commends the positive direction of the American economy, especially due to the fiscal spending measures.

While the American economy currently posts substantial gains, it is expected to slow as the presidential election season approaches. On the other hand, the Canadian economy, presently flirting with recession, is predicted to pick up next year, possibly aligning with a federal election in 2025.