The Organization for Economic Co-operation and Development has published its latest survey of Canada, suggesting that interest rates may have to begin rising again as the economic downturn passes.

The OECD says that economic growth in Canada is projected to strengthen again in the second half of this year and in 2002, for several reasons. The United States economy is projected rebound, with the OECD forecasting U.S. growth above 3% in 2002. The OECD also cites the completion of the inventory correction, the continued impact of Canadian tax cuts, and the recent easing in monetary conditions.

The OECD survey notes that, “With export demand and stockbuilding no longer acting as drags on growth, the economy is projected once again to grow faster than estimated potential through 2002.” Canadian inflation is also expected to remain restrained.

There are downside risks to the forecast. The main risk is the possibility that the slowdown in the U.S. could be deeper and more protracted than anticipated. Apart from the direct trade and financial effects, confidence and thus spending propensities of businesses and households in Canada might be adversely affected if a recession developed in the U.S. or the rebound were delayed, it says.

The OECD observees that recent rate cuts have been justified in Canada, but, “With the recent uptick in core inflation and the diminished risk of a U.S. recession, this process should have reached an end, unless incoming indicators point to a longer- or stronger-than-expected downturn. A start to the process of reversing this year’s interest-rate declines would be required when activity again approaches potential output, which is currently expected in mid-2002.”

It also notes that a more ambitious debt-reduction plan might be desirable, given that Canada’s public debt ratio is still higher than that of most other OECD countries. It expects more tax cut pressure to emerge. “Despite the significant cuts enacted, statutory and especially average personal income taxes remain higher than south of the border, and recently enacted U.S. measures will, over time, broadly re-establish the previously existing statutory personal income tax gap. Thus, pressures to make further adjustments to the tax system are likely to resurface.”

The OECD recommends that government spending decisions should not be made on an ad hoc basis but “within a medium-term framework and after careful evaluation of their benefits”. The government has recently moved to presenting five-year fiscal projections based on private-sector forecasts. “It would be preferable if the budget also presented the full impact of all new measures on the five-year fiscal projection.”