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Canada on alert as U.S. nears fiscal cliff

If the U.S. government runs off the fiscal cliff, some economists say the U.S. will go into recession, and Canada will see up to 1.8 per cent chopped from its real GDP as a result.

KEVIN LAMARQUE/REUTERS

Serious economic problems are threatening to bleed over the border from the United States into Canada in the wake of the presidential election.

The Canadian economy is so dependent on the economic performance of the United States, which is grappling with a tenuous recovery, that policy missteps in Washington "could be very challenging for the Canadian economic recovery, which is similarly fairly tenuous," said Paul Taylor, chief investment officer for fundamental equities at BMO Asset Management.

On a post-election conference call Wednesday, Mr. Taylor predicted there will be a "period of unease as we now turn from the politicking to the heavy lifting," particularly on the issue of keeping the U.S. economy from tumbling over the "fiscal cliff."

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U.S. Federal Reserve Board chairman Ben Bernanke coined that phrase last February to describe the hundreds of billions of dollars in automatic government spending cuts and tax increases that will take effect Jan. 1 in a budget-deficit-reduction orgy, unless the politicians find some middle ground.

Economists' estimates of the potential damage vary, but a widely circulated projection is that as much as $800-billion (U.S.) would be carved out of U.S. gross domestic product in 2013 – about 4 per cent of the economy – if the automatic provisions come into play.

Toronto-Dominion Bank economists say that if the U.S. government runs off that cliff, the U.S. economy will certainly go into recession, and Canada will see 1.2 per cent to 1.8 per cent chopped from its real GDP as a result. If that happens, Canada will just narrowly avoid a recession itself, the bank says.

Still, said TD's deputy chief economist Derek Burleton, the chances of that worst-case scenario coming to fruition is slim. Much more likely, he said, is that there will be a compromise – probably at the last minute – and that could result in a much smaller dent to the U.S. economy and to Canada's, depending on the mix of spending cuts and tax increases agreed to.

A compromise – based on President Barack Obama's election promises – could cut the impact on GDP in the United States to about 1.5 percentage points, and the Canadian hit would then be reduced to about 0.5 to 0.7 per cent, TD calculates.

Another scenario could see some sort of deal that delays a final decision. That would still dampen growth in both Canada and the United States, as business would remain leery about investing and hiring because of the uncertainty, Mr. Burleton said in an interview. "That is a kicking-the-can-down-the-road kind of thing."

In that case, however, the reduced economic activity that results from the uncertainty might be recouped later on, once an agreement is reached, he said.

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Another issue is the mix of tax increases and spending cuts that could be put in place in the United States. Tax increases would hurt Canada more, because they have more of a direct impact on Canadian exports, TD says. Government spending cuts would have more of a domestic effect south of the border.

And even if a deal were struck, Mr. Burleton said, there will still be looming questions about the U.S. government's long-term deficit challenge, and the pressing need to raise the country's debt limit.

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About the Author
Reporter, Report on Business

Richard Blackwell has reported on Canadian business for more than three decades. At the Financial Post and the Globe and Mail he has covered technology, transportation, investing, banking, securities and media, among many other subjects. Currently, his focus is on green technology and the economy. More

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