VICTORIA, British Columbia (Reuters) - The 'fiscal cliff' of expiring tax breaks and budget cuts in the United States from early 2013 could partly explain why Canadian exports were unexpectedly weak over the past two years, a senior Bank of Canada official said on Thursday.
Deputy Governor John Murray said in a speech that there had been an apparent disconnect between foreign demand, particularly in the United States, and the performance of Canadian non-commodity exports.
This has puzzled policymakers but recent evidence suggests exports rely more heavily than thought on demand from U.S. governments at the federal, state and local level, with about 12 percent of non-commodity exports from 1997 to 2012 going to the U.S. government sector.
By recognizing that, the bank is better able to understand the export weakness, Murray said.
"It relates to the fiscal cliff in the United States and the significant budget consolidation that has been underway there in the past two years," Murray said in his last public speech before retiring on April 30.
The fiscal cliff refers to expiring U.S. tax breaks and spending cuts that took effect from January 1, 2013, which had the potential of pushing the U.S. back into recession in the absence of an alternative deficit-reduction deal by U.S. politicians.
Murray stressed that this explanation for weakness in Canadian exports was a work in progress and not the only cause.
The two big challenges to economic growth in Canada are weak inflation combined with excess slack in the economy, as well as an over-reliance on household spending to drive growth.
In addition to scratching their heads over the lagging exports in Canada, central bank officials have had trouble understanding why inflation has been so weak and why business investment has not bounced back as expected after the 2008-09 recession.
These trends are international too and better understood when seen in that context, Murray said.
While domestic factors likely play a role in disinflation, central bankers have learned from other countries that the effect of output gaps on inflation has a longer lag than previously thought, when these gaps are large and persistent.
"Indeed, the sensitivity of prices to excess supply might increase through time," Murray said.
He said U.S. researchers have shown that uncertainty weighs significantly on business investment decisions.
Murray provided no new guidance on Canadian monetary policy in his speech.
Writing by Louise Egan and David Ljunggren; Editing by Bernadette Baum