Why Canada Lowered Interest Rates First... While the US Hasn't Yet

원본보기 아이콘

Among major countries worldwide, Canada was the first to lower its benchmark interest rate, drawing attention to the background of the rate cut. In particular, the United States, which has close economic and social ties with Canada, has pushed back the expected timing of its rate cut, while Canada’s decision to lower rates has increased interest in the differences in economic conditions between the two countries.

According to the report titled "Differentiating Factors and Implications of the U.S. and Canadian Economies" by the Bank of Korea’s New York office on the 8th, the U.S. and Canada have shown close socio-economic correlations due to geographic proximity, tight trade relations, and similar socio-cultural structures. However, recently, the U.S. economy has remained robust while Canada’s economy has shown signs of slowing down.

After the COVID-19 pandemic, both countries generally exhibited similar economic trends, but since the second quarter of last year, the U.S. has recovered to pre-pandemic trends with unexpectedly rapid economic growth, whereas Canada’s economic growth rate has slowed, falling below its potential growth rate (2.3%).

While inflation in the U.S. has remained in the mid-3% range, Canada’s inflation has been declining below 3%, prompting the Bank of Canada to become the first among the G7 countries to implement a rate cut on the 5th.

Source: Bank of Korea

원본보기 아이콘

The Bank of Korea’s New York office cited differences in household debt structure, fiscal policy utilization, immigration policy effects, and industrial structure as major factors differentiating the U.S. and Canadian economies.

First, regarding household debt structure, most U.S. mortgage loans are long-term and fixed-rate, whereas Canadian mortgages have maturities of only 3 to 5 years, causing Canadian households to face rapidly increasing refinancing and interest costs during periods of rising interest rates compared to the U.S.

At the end of last year, the debt service ratio (DSR), which is the ratio of interest payments (including principal repayments) to household income, stagnated in the U.S. at the high 7% range similar to pre-pandemic levels, while in Canada, it has been rising since early 2022, reaching 14.4%, nearly double the pre-pandemic level.

The increased mortgage interest burden on Canadian households has reduced disposable income, resulting in a sharper slowdown in consumer spending compared to the U.S.

There is also a difference in the use of fiscal policy between the two countries. During the pandemic, the U.S. was the most aggressive among major countries in utilizing fiscal policy, which significantly contributed to the rapid recovery of growth rates deviating from the trend back to normal trajectories. Canada also expanded fiscal spending during the pandemic, but to a lesser extent than the U.S., resulting in relatively limited growth recovery effects.

Differences were also observed in the effects of immigration policies. Recently, Canada, despite having a smaller economy than the U.S., has seen a sharp increase in immigrants relative to its population, leading to rising unemployment rates and increased social costs for settling immigrants, highlighting the negative effects of immigration more prominently.

Canada’s immigration policy, compared to the U.S., focuses on economic settlement from a mid- to long-term perspective and requires an incubation period to produce skilled workers, resulting in relatively lower immediate economic stimulus effects.

Industrial structure is also a factor differentiating the two economies. Canada’s domestic market is small due to population shortages, but its GDP relies heavily on exports centered on raw materials, and its trade openness is high, making it more vulnerable to global economic slowdowns than the U.S.

The Bank of Korea stated that the differentiation phenomenon and factors between the U.S. and Canadian economies provide certain implications for Korea’s economy and policies.

Since Korea’s financial market and household debt structure are similar to Canada’s, Korean households are likely to respond more sensitively to changes in monetary policy (short-term interest rate fluctuations) and may be more vulnerable to risks such as housing price declines and income reductions during periods of rising interest rates.

Additionally, as Korea is considering expanding immigration as one of the alternatives to address demographic issues such as declining birth rates, it emphasized the need to closely examine the economic and social impacts of immigration policies in both countries and the differences in their policies.

Furthermore, given Korea’s economic scale and industrial structure are insufficient to attract voluntary migration by foreigners like the U.S., and considering the lower inclusiveness in language (Korean) and culture (homogeneous ethnicity), the Bank of Korea added that the Canadian model, which allows an incubation period for immigrants’ social and economic settlement, is desirable.

© The Asia Business Daily(www.asiae.co.kr). All rights reserved.