The Canadian Government and the Bank of Canada success in running the Canadian economy over the last two years
Canada stands at a critical point in history given that economic supremacy is shifting from the West to East and trade and investment patterns are transforming. What’s more, this is happening at a point when key players (i.e. U.S) are facing demographic, monetary and fiscal impediments.
Although the 2008 global economic meltdown forced Canada into a mild depression, it nevertheless recovered from the crisis and is currently in a better position to revive its economic affiliation with the US as well as pursue new prospects with emerging key international players (Abdool, Olender & William-Zannis 2011).
The current situation
The Department of Foreign Affairs and International Trade (DFAIT) has established a number of priorities for 2011-12 periods. These include: fostering economic partnership with United States; and pursuing economic opportunities in emerging economies. Other priorities pursued within the trade and investment framework are:
- Adopting the Global Commerce Strategy to augment Canada’s commercial participation in global trade, with special focus on Brazil, India and China.
- Marketing Canada’s advantage as a viable investment destination.
- Expanding global research and development joint ventures with an aim of commercializing innovation.
- Executing free trade pacts with new strategic trade partners
- Promoting foreign investments negotiations (Abdool, Olender & William-Zannis 2011).
The government of Canada aims to augment bilateral trade and investment pacts with the United States as well as rising economies, especially Brazil, China and India. In addition, the government intends to reinforce multilateral pacts via Doha Round trade concessions under the WTO (Abdool, Olender & William-Zannis 2011).
Canada’s Bilateral and Multilateral Pacts
The most widespread bilateral pact in the world is the Canada-US trade and investment pact which boasts of an aggregate trade value estimated at CAD$500 billion in 2010. It is important to note that the Canada-US trade pact, established under the auspice of the North American Free Trade Agreement (NAFTA), remains the most significant aspect of Canada’s trade portfolio.
As a matter of fact, the trade pact is the basis of Canada’s standard of living as well as wealth. For example, Canada’s exports (under the Canada-US trade pact) represented 35% of its GDP in 2010. In terms of foreign direct investments, the United States is the largest foreign investor in Canada.
On the other hand, Canada is ranked the fifth biggest foreign investor in the United States. This phenomenon is evidenced by the fact that in 2010, over 52% of all foreign direct investments in Canada came from the United States (Canadian Industry Statistics 2011).
In 2010, the economy took an upward turn when Canadian exports rose by 11%. In addition, the value of Canadian exports rose to $399.4 billion in 2010, up from $360 billion in 2009 (Canadian Industry Statistics 2011). Canada has also expanded its trade and investment pacts with emerging economies.
For example, China was ranked as the third biggest trading partner with Canada in 2010 as exports rose to CAD$11.2 billion, representing a 6.6% increase. India was ranked as the 10th largest trade partner with exports from Canada totalling CAD$2.1 billion while Brazil was ranked 13th with exports from Canada equalling CAD$1.6 billion (Macklem 2011).
Canada has played an integral role with respect to multilateral pacts such as General Agreement on Tariffs and Trade (GATT) and World Trade Organization (WTO). As a matter of fact, DFAIT has prioritized the advancement of the Doha Round concessions which have been continuing ever since 2002.
Canada’s supply management strategies are regarded as significantly weakening its potential multilateral development to its trade position. Nonetheless, the government of Canada aspires to protect the supply management structures for poultry and dairy products in which restrictive levies are enforced on the imports of products above a tariff rate quota (Barichello 2011).
Canada’s Global Commerce Strategy
In order to augment Canada’s fragile business position in rising economies, the government implemented the Global Commerce Strategy in 2009.
Under this strategy, the government of Canada aims to buttress Canada’s competitive advantages, support local companies engaged in global commercial ventures as well as attract foreign investments in the country. The government, under the Global Commerce Strategy, has set a number of priorities targeting emerging economies such as Brazil, India and China. These include:
- Augmenting Canada’s commercial engagements in international value chains
- Securing networks for local business as well as acquiring competitive terms of trade in the international market.
- Enlarging foreign direct investments in Canada as well as Canada’s investments around the globe (Government of Canada 2009).
In order to augment Canadian trade, the Government of Canada has lent credence on NAFTA as the main basis for economic prospects. In addition, the government has signed a number of trade pacts including science and technology concessions and FTAs pacts in addition to supporting DFAIT’s Trade Commissioner Services.
In order to boost Canadian share of international investment, the government has prioritized a number of programs. These include: pursuing FIPAs; funding Going Global Innovation program; and adopting Foreign Investment Promotion Strategy to market Canada in major markets in order to attract potential foreign investments to specific industries across Canada.
The government of Canada has also put in place strategies to assist foreign investors in the country establish links with Canadian innovative networks, labour, professionals and suppliers (Abdool, Olender & William-Zannis 2011).
Financial Stability
The major challenge posed by the current inflation-targeting structure in Canada arises from anxieties regarding financial stability. It is worthy to mention that financial stability has traditionally been addressed by the Bank of Canada given its role as the lender of last resort. Concerns about financial stability have produced several new initiatives in recent years.
For instance, the Bank of Canada restructured its economic and operational department in 2008 to concentrate on financial stability. More importantly, this process was completed before the recent economic meltdown occurred. As a matter of fact, the Bank has customarily pursued a dichotomy whereby monetary policy and interest rate policy are one and the same.
Its other roles (i.e. administering the payment system or dealing with financial crises) have been kept apart. Interest rate policy was dedicated to attaining the inflation target using a structure that also stabilized real output (Melino 2012, p.108).
The Bank of Canada, in contrast to other central banks, does not regulate financial institutions. Following the 2008 financial meltdown, the Bank of Canada produced a dynamic policy response. For instance, the Bank offered unexpected direction by making a conditional pledge on the outlook for inflation in order to maintain the policy rate set at the effective zero lower bound between 2009 and 2010 (Amano & Shukayev 2010, p.1).
In addition, amendments to the Bank of Canada Act were adopted in 2008 to enable the Bank raise its lending term facilities as well as to enlarge the number of counterparties for whom it could grant liquidity. During the crisis, the balance sheet of the Bank nearly doubled and its composition shifted away from the government securities as a result of the collateral it allowed at its different liquidity facilities (Melino 2012, p.109).
What’s more, the financial system in Canada was not affected by the 2008 financial crisis. Neither the government nor the Bank provided direct capital injections to financial institutions and banks in Canada because they did not require them. In addition, the Bank did not participate in substandard monetary policy (i.e. quantitative or credit easing).
Furthermore, the exit from difference initiatives launched by the Bank of Canada in reaction to financial meltdown commenced ahead of schedule and was swiftly completed without incident. Thus, the overnight rate was at 1% while the provisional rise in the Bank’s balance sheet was principally unwound and its composition was reinstated by September 2010 (Melino 2012, p.109).
There are a number of propositions put forward to explain why the Canadian economy weathered the storm caused by the recent financial meltdown. These include: Canada’s traditional regulatory framework; the absence of enticements required by Canadian banks to leverage risks emerging from their claim to oligopoly rents; and the predominance of non-alternative mortgage finance (Melino 2012, p.110).
The main macroeconomic policies used by the Canadian Government and the Bank of Canada over the last two years
The Zero Lower Bound
It has long been perceived that attaining the zero lower bound (ZLB) with respect to the policy rate would significantly decrease the ability of the Bank of Canada to stabilize the economy. However, when the policy rate dropped to 25 basis points in April 2009 (assumed to be the desirable ZLB), the Bank announced a number of actions that it would adopt (if required) to accomplish its inflation target.
Eventually, the Bank implemented only one of these substandard measures (a provisional pledge to maintain the policy rate set at the effective zero lower bound until June 2010).
The pledge was nonetheless subject to the outlook of inflation and Bank officials made significant efforts to inform markets that the policy rate would be increased if it was deemed that failure to do so would result in a path for inflation that would transcend the Bank’s 2% target. It is important to note that the conditional pledge played an integral role in helping the Canadian economy to ride out of the depression swiftly.
The preliminary impact of the pronouncement of the conditional pledge did not prompt economic agents (firms and households) to increase their spending. On the contrast, it helped alleviate fears that the monetary authority would increase the policy rate from its effective low level.
Thus, the constant announcements from senior officials that the Bank of Canada would uphold its conditional pledge accelerated economic recovery from recession (Melino 2011).
Financial Stability
It is worthy to mention that the 2008 financial meltdown did not affect the financial system in Canada. This is mainly attributed to the restructuring program implemented in 2008 by the Bank of Canada on a number of its department to enhance financial stability. In addition, the Bank has traditionally been deemed as the lender of the last resort.
What’s more, the Bank of Canada is legally responsible for ensuring the safe working of the country’s payment systems. In contrast to Central Banks in other countries, the Bank of Canada does not regulate financial institutions. Nevertheless, the Bank of Canada is known to apply judgment in reaction to unusual financial events.
For instance, in reaction to the financial meltdown that occurred after the Lehman Brothers collapsed, the Bank took part in a globally synchronized 50 basis point slash in its target rate which was outside of the typical fixed cycles of pronouncement days (Melino 2011).
Communication
Economic model do not offer sufficient assistance regarding the best way to convey information required by the markets and public to formulate their expectations regarding actions by the Bank of Canada.
Therefore, from a communication perspective, using inflation targeting in communication can bestow real benefits. For instance, the Bank of Canada has polished its communication policy under inflation targeting in order to make it somewhat easy for the Bank to convey its message across the board (Melino 2011).
Inflation Targeting
The Bank of Canada, ever since 2006, has actively taken part in a research program to assess the benefits of adopting a system that lends credence to the price level as opposed to inflation rate (Murchison 2010, p.11). When the Bank of Canada launched its inflation targeting, it regularly used the term band to refer to its inflation target which has fluctuated between 1 and 3% ever since 1995.
Nevertheless, in the last two years, the Bank’s inflation target has prominently revolved around the midpoint of 2% and the Bank has stressed that its inflation target is the mid-point of its band.
At first, it was anticipated that the stress on the band would bestow a kind of confidence interval required by the public in establishing its expectations. Nonetheless, the Bank of Canada was eventually successful in attaining the 2% mid-point that it had anticipated (Melino 2011; Murray 2010).
The effective Lower Bound
The Bank of Canada reduced its policy rate to 25 basis points in 2009 and confirmed it as the effective lower bound for the overnight rate. The Bank was concerned that if its policy rate had a lower value, it would generate commotions in the overnight market thereby obstructing liquidity.
With no prospects for going back to overnight lending, financial institutions might even opt to shut down their operations which might lead to a loss of human capital. As a result, the operation of monetary policy would be hampered after the zero lower bound episode end (Melino 2011).
Uncertainty
The Bank of Canada employs a somewhat archaic apparatus to integrate the costs of uncertainty for developing monetary policy. The present practice is to compose a base case projection and then make out a small number of precise risks associated with this projection. There are many sources of uncertainty such as parameter uncertainty, model uncertainty and distribution of future shocks.
However, assuming that shocks are diminutive and nonlinearity is negligible, then lending credence to the base case projection is more or less desirable. Nevertheless, these conditions have not been fulfilled by the Bank in the last two years (Melino 2011).
References
Abdool, I., Olender, M & William-Zannis, A 2011, Canadian Trade and Investment Policy Review, Carleton University, Ottawa.
Amano, R & Shukayev, M 2010, ‘Monetary Policy and the Zero Bound on Nominal Interest Rates’, Bank of Canada Review, pp. 3-10.
Barichello, R 2011, Options for Supply Management in Canada with Trade Liberalization: Canadian Agricultural Trade Policy Research Network. Web.
Canadian Industry Statistics 2011, International Trade: Canadian Economy. Web.
Government of Canada 2009, Seizing Global Advantage: A Global Commerce Strategy for Securing Canada’s Growth & Prosperity, Public Works and Government Services, Ottawa.
Macklem, T 2011, Canada’s Competitive Imperative: Investing in Productivity Gains. Web.
Melino, A 2012, ‘Inflation Targeting: A Canadian Perspective’, International Journal of Central Banking, vol. 8 no.1, pp. 105-131.
Melino, A 2012, Moving Monetary Policy Forward: Why Small Steps and a Lower Inflation Target Make Sense for the Bank of Canada, C.D. Howe Institute, Toronto.
Murchison, S 2010, ‘Price-Level Targeting and Relative-Price Shocks’, Bank of Canada Review, pp. 11-21.
Murray, J 2010, Re-examining Canada’s Monetary Policy Framework: Recent Research and Outstanding Issues. Web.
Bibliography
Bordo, M., Redish, A & Rockoff, H 2011, Why didn’t Canada have a Banking Crisis in 2008 or in 1930, or 1907?, National Bureau of Economic research, Cambridge, MA.
Lane, T 2009, The Canadian Economy Beyond the Recession, The Canadian Association for Business Economics, Ontario.
Rabbior, G 2001, The Canadian Economy: The Big Picture, Canadian Foundation for education, Ontario.
Stanford, J 2012, A Cure for Dutch Disease: Active Sector Strategies for Canada’s Economy, Canadian Centre for Policy Alternatives, Ottawa.
Stamford, J 2010, Out of Equilibrium, Canadian Centre for Policy Alternatives, Ottawa.