An insight into the mind of the Bank of Canada and infinite growth

Happy Victoria Day Weekend, for those readers who live in Canada.  And for anyone else, have a happy weekend anyway.

Periodically I try to engage with the Powers That Be about the subject of infinite growth (impossibility of).  It’s rather like binge drinking: it seems like a good idea at the time but I always regret it afterwards and need a few aspirin to recover.  Here is my latest correspondence with a nice lady called Natalie at the Bank of Canada, who is obviously doing her best to be helpful.  I asked the bank to clarify their recent statements on “full capacity” and “sustainable economic growth”.  I’ve published the full correspondence here but added a few comments of my own at the bottom.

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From: Nathalie Smith [mailto:nsmith@bank-banque-canada.ca] On Behalf Of Public Information/Information Publique Sent: Thursday, May 14, 2015 11:28 AM To: Peter Gray Subject: RE: Full capacity?

Dear Mr. Gray,

In that context, economic growth refers to real GDP growth. Also, real GDP and potential output are related concepts, as potential output is the level of real GDP that can be sustained in an economy without adding inflationary pressures. As indicated in the previous response, reaching full capacity around the end of 2016 means that the level of real GDP will have returned to the level of potential output.

Because the Bank judges that there is excess capacity at the beginning of the projection horizon (i.e., the level of real GDP is lower than that of potential output), real GDP growth will need to be temporarily faster than projected potential growth to bring the real GDP to the same level as potential. Thereafter, full capacity will be maintained if real GDP grows at the same rate as potential output.

Sustainable growth means that the economy is operating at full capacity and growing at the rate of potential output. At the same time, the composition of the drivers of aggregate demand needs to be balanced. In this regard, the Bank has been saying that, in order for the Canadian economy to return to sustainable growth, we need a rotation of demand toward exports and business investment.

Best regards,

Nathalie Smith, Public Information Agent/Agente de l’information publique

From: Peter Gray  Sent: May 13, 2015 11:30 AM To: Public Information/Information Publique Subject: RE: Full capacity?

Thanks Natalie, but I would be grateful for one further point of clarification.  Can you confirm that economic growth and economic capacity are completely independent variables?  I quoted you the sentence

“Economic growth in Canada is expected to average 2.1 per cent in 2015 and 2.4 per cent in 2016, with a return to full capacity around the end of 2016” (January 2015 Monetary Policy Report)

because I found it confusing, because economic growth and economic capacity were talked about in the same sentence as though they were equivalent.  However, from what you are saying, I understand that they are independent.  So, for example, am I correct in thinking that you could (hypothetically) have economic growth of zero percent but still have full economic capacity?  That would presumably be the case if the economy did not grow between 2016 and 2017 but real GDP and potential output remained in balance (i.e. excess capacity was also zero)?

Also I have a separate question: can you explain what is meant by “sustainable economic growth”?  This phrase is used in several Bank documents, for example, “Double Coincidence of Needs: Pension Funds and Financial Stability” (Speech, Lawrence Schembri, 15 May 2014).  Over what period does the bank judge economic growth to be sustainable?  For example, if you have economic growth of 2.5% per annum, this would result in growth to 720% of original size over 80 years, 5184% over 160 years, 37,324% over 240 years, and so on, which does not appear sustainable over very long periods.  So does the Bank have a shorter time frame within which it considers growth “sustainable”, and if so, what is that time frame?

Thank you!

Peter Gray

From: Nathalie Smith [mailto:nsmith@bank-banque-canada.ca] On Behalf Of Public Information/Information Publique Sent: Wednesday, May 13, 2015 11:05 AM To: Peter Gray Subject: RE: Full capacity?

Dear Mr. Gray,

In response to your inquiry, “The Bank expects that the economy will reach full capacity around the end of 2016.” (p. 21)

In that context, full capacity means that the level of real GDP will have returned to the level of potential output.

Recall that the amount of excess capacity at the beginning of the projection horizon (i.e., 2015Q1) is estimated to be between 1/2 and 1 1/2 per cent, with the projection constructed around the midpoint of that range (i.e., -1 per cent). (p. 20)

Additional information about the potential output can be found in the “Appendix: Updated Estimates of Potential Output Growth” (pp. 31-32).

Best regards,

Nathalie Smith, Public Information Agent/Agente de l’information publique

From: Dr. Peter Gray [mailto:pgray@bayviewmedical.ca] Sent: May 12, 2015 9:13 PM To: Public Information/Information Publique Subject: Full capacity?

Dear Bank of Canada

Please will you explain what is meant by “full capacity” as in:

“Economic growth in Canada is expected to average 2.1 per cent in 2015 and 2.4 per cent in 2016, with a return to full capacity around the end of 2016” (January 2015 Monetary Policy Report)

Thank you!

Peter Gray

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My comments on the above

Infinite economic growth is clearly impossible, as I demonstrated to Natalie with my calculation of how, for a 2.5% annual growth rate, the economy would have to grow to over 37,000% of its original size over a 240 year period.  Natalie obviously can’t admit that infinite economic growth is impossible – that would go against all her training and all the Bank’s policies – so she tries to sidestep it with a number of arguments which actually don’t make sense when you examine them carefully.

“Potential output is the level of real GDP that can be sustained in an economy without adding inflationary pressures”

No, these seem to me to be two completely different concepts.  “Potential output” and “real GDP” relate to what is physically produced in the real world.  So if you have a factory which has enough machines to produce 100 widgets per day, but only 50 widgets per day are being produced per day and 50% of the machines are standing idle, then you have 50% of potential output being produced.  “Inflation” on the other hand is an artificial concept relating to the amount of money in the economy, which can be increased or decreased independently of physical output.

“Full capacity will be maintained if real GDP grows at the same rate as potential output.”

True, but full capacity would also be maintained if there was no growth of either real GDP or potential output, i.e. if they both remained the same.  Using the widget factory example above, the factory could remain the same year after year, producing the same number of widgets with the same number of machines.

“Sustainable growth means that the economy is operating at full capacity and growing at the rate of potential output”

No, this is simply not true.  Sustainable growth means that there are enough physical raw materials to allow growth to occur.  If the supply of raw materials is limited, then if the economy is already operating at full capacity, no further growth is possible.  If each widget in the example above requires 1 ounce of plumbium to manufacture, and only 50 ounces of plumbium per day can be sourced, then the potential output is 50 widgets per day, the actual output is 50 widgets per day, the widget factory needs to dispose of its surplus machines because it is already operating at full capacity, and no further growth is possible.

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2 thoughts on “An insight into the mind of the Bank of Canada and infinite growth

  1. Thank you for forwarding the informative correspondence. I liked the example of the widgets. The Bank wants a focus toward investment and export, which would mean making more widgets for export. How are we going to continue getting the raw materials to make ever increasing numbers of widgets? Or for that matter all the consumer goods we buy everyday? I live in a large agricultural area. We got our first neighbor a few years ago. When I venture to the large Canadian cities I am amazed at the population growth, construction boom, and the increased variety of goods available in stores. But when I come home I notice we have no more soil, no more water, and no additional natural resources with which to grow more food. People do not realize that even small changes in weather with a wetter summer or spring can impact crops. There simply is no way we can have sustainable indefinite growth.

  2. Mr. Grey.

    Here are my 2 cents:

    1. Sure, the infinite growth is not possible from a common sense point of view.
    2. The problem is – the economy doesn’t care about anything real. It just needs to balance the books. So, from this prospective there is nothing which can prevent an infinite growth on paper. The unit of measure is $CAD. And we can see the economy grew up tremendously during last century, but as a matter of fact we do not eat twice as much.

    3. There is total disconnect from the “Modern” economy and real life. Here is just one example:
    Can you imagine you told your family that you created more work places at home?
    This would be insane. We all expect to eliminate the need to work, this is called solving problems instead of creating them. But in the “economy” we think it is a good thing to create more workplaces, instead of actually reducing them.

    Thanks,
    Andrei.

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