Canada must have found some economic progress in the pocket of an old winter coat. Last week Statistics Canada (Stat Can) made some big upward revisions to the country’s gross domestic product (GDP) data. The country’s national statistics agency found the equivalent of a whole year of economic activity that was hiding between 2021 to 2023. That’s good news for the economy, which is apparently doing much better than previously thought. However, that’s bad news for the central bank who’s now finding out it made a supersized rate cut to address deflationary pressure presented by an output gap that was just eliminated.
Canadian GDP Got An Upward Revision Equal To A Year’s Worth of Activity
Canadian GDP got a big upward revision last week with the provincial data. Stat Can looked deep in its couches and found a whopping 1.3% underreported growth from 2021 to 2023. The provincial data took the headlines, but this was really the big news.
“The latest annual provincial GDP estimates were perhaps most notable for the big upward revisions to growth for the country as a whole,” stated Douglas Porter, chief economist at BMO.
He further explains, “To briefly recap, the past three years have been revised up by a cumulative 1.3 percentage points: 2023 goes to 1.5% (from 1.2%), 2022 to 4.2% (vs 3.8%) and 2021 all the way up to 6.0% (5.3%).”
It’s hard to emphasize just how much growth had been underreported. Annual GDP growth was originally reported at 1.2% last year, and the total revision over a 3-year span was bigger. It’s like they discovered a whole extra year of output they missed over a short span. Whoops!
Bank of Canada Made A Supersized Cut To Address Deflationary Pressure That Didn’t Exist
Most people will likely hear the upward revision and assume it just means the economy grew faster. Yay! But it brings up a lot more immediate questions—the ones off the bat are how is this possible with such weak revenues and elevated unemployment? It also brings up a less obvious and more important issue—the output gap is much smaller than believed.
The output gap is the difference between what the economy produces and what it could produce. An economy that performs below its output gap is said to be in a phase of oversupply, meaning not enough is being consumed relative to the amount the economy can produce. A positive output gap is considered undersupplied, and an inflationary risk. It’s one of the most important factors a central bank considers when assessing the direction of interest rates.
The Bank of Canada (BoC) tries to get CPI at the target, and maintain a minimal output gap. When making its last rate cut, CPI was pretty darn close to the central bank’s target rate but the BoC made the country’s first non-recession 50 basis point (bp) rate cut. It was concerned the output gap implied the economy was oversupplied and needed a lot more stimulus to prevent deflation.
“While this may seem like ancient history, the BoC’s latest MPR pegged the output gap between -1.75% and -0.75%. The mid- point of that range is -1.25%, or almost precisely how much the level of real GDP just got revised higher,” explains Porter.
In plain English, the revision means the output gap is much smaller than they had originally believed. The current BoC output gap is estimated at -1.1% according to their website, meaning inflation is actually slanted to the upside—not in favor of deflation, as per the reasoning for panicked rate cuts.
At this point, it may not really matter what inflation and output is reported, model adjustments seem to always err on the side of perfect. First there was the way inflation was modeled, with a Big Six bank warning the new adjustments will chronically underreport inflation. Now there’s the massive revision post the largest non-recession rate cut in the BoC’s history. There’s little doubt more data revisionism is in the pipeline.
“No fear, the BoC will likely now revise their estimate of potential growth higher as well,” says Porter.
The upside to all of this is Canada’s per capita GDP will be revised. BMO says this will make the past 3 years less painful statistically, though not enough to really change concerns.
“The 2023 level is now exactly in line with 2019 (instead of falling 1.3% over that period). Still bad, but less horrendous,” he notes.
The bank sees at least one good data point, but most of the public is unlikely to be as excited as they are. Originally in 2021, they forecasted the economy would grow at a rate of 6%, an unusually large miss for the bank’s economists.
“..: The first estimate from StatCan for that year was 4.5% (in 2022). Last year, it was revised up to 5.3%, and now to 6.0%. Sigh,” explains the economist, who can now sleep easy knowing he wasn’t off, apparently Canada just needed to catch up.
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