JEREMY KRONICK
OTTAWA – A new leading economic indicator is flashing warning signs, according to a new C.D. Howe Institute report.
In “Tell-tale Signals: A Customized Toolkit for Tracking the Economy,” authors Jeremy Kronick, Steve Ambler and Mawakina Bafale introduce a leading economic activity index for Canada based on freely available, downloadable data. This tool is a part of the C.D. Howe Institute’s customized toolkit for tracking the economy.
“Bringing together research from past Institute studies, the goal of this report is to present a customized series of data sets and discuss how they can be helpful for policymakers and other parties to analyze monetary policy and financial stability decisions,” says Kronick, Associate Vice President and Director of the Centre on Financial and Monetary Policy at the Institute.
The leading economic indicator is part of a toolkit of indexes that also includes: The financial vulnerability indicator; the money overhang index; a statistical decomposition of Canadian inflation into supply- and demand-side drivers; the monetary policy stance indicator; and the diffusion index. These data should be considered complementary to existing publicly available variables. The C.D. Howe Institute’s Centre on Financial and Monetary Policy will update these data monthly with free access for both decision-makers and the public.
Overall, using the indicators, the authors suggest that the Bank of Canada’s monetary policy tightening cycle should be coming to an end, and the Office of the Superintendent of Financial Institutions’ Domestic Stability Buffer, designed to cover potential losses at Canada’s largest banks in periods of financial stress, should be kept steady.
Notably, the leading economic activity index, which has performed well in advance of previous economic downturns and periods of stress, is falling. Its drop is commensurate with previous declines during the 2001 dot-com crash and the 2008 Great Financial Crisis, they write.
“The current level of economic activity is where it was in February 2021, the last time inflation was at or below the 2 percent target,” says Ambler, a Fellow-In-Residence with the Institute. This warning is further supported by other data that show economic activity is flagging across a number of industries.
“With economic activity typically leading inflation, inflation seems set to continue back to the 2 percent target – a point confirmed by the gap between trend money growth and trend inflation in the money overhang index having returned to where it was pre-pandemic,” says Bafale, a Research Officer with the C.D. Howe Institute.
Meanwhile, the financial vulnerability indicator – which tracks vulnerabilities across the banking, corporate, housing, and household sectors, with a high score indicating increased vulnerability – has dropped from its 2022 peak but is still above zero.
Kronick, Ambler and Bafale also find that the majority of the remaining inflation comes from the supply side. This doesn’t imply the Bank can’t or shouldn’t further tighten its overnight rate to bring inflation back to target, however, they say the economic costs of doing so with inflation stemming from the supply side are greater.
Other key indicators examined include the monetary stance indicator, which uses different versions of the Taylor rule to estimate the appropriate level for the Bank of Canada’s target overnight rate as well as the diffusion index, an index that measures the extent to which expansions and contractions are widespread across different sectors of the economy. The former shows the Bank’s current overnight rate in range, while the latter has been trending downward for a number of months.
