by Brian L. Scarfe
University of Alberta
Manitoba History, Number 4, 1982
|
This book addresses an important and topical subject, namely Canada’s unemployment problem. Its main theme is that the divergence in the Canadian and U.S. unemployment rates between 1976 and 1979 is attributable to Canadian monetary policy. What is clear in retrospect is that in reaction to its excessively easy monetary policies in 1971-74, a looseness that permitted our relative costs and prices to get out of line with those in the United States, the Bank of Canada initiated in the fall of 1975 a monetary policy which was expressedly but necessarily tight, and continued to be so at least until the spring of 1977. The impact of this policy was to create an historically large interest rate differential vis-a-vis the United States, to generate large scale capital inflows, and to postpone the necessary downwards adjustment of the Canadian dollar that our previous inflationary excesses had made inevitable. The unemployment cost of this policy has been substantial, both because of its negative impact on the trade balance, and because it reduced the volume of investment in Canada—both directly through higher interest rates and indirectly via the capacity-utilisation effects of an over-valued exchange rate.
Barber and McCallum argue that the Bank’s policies were in the wrong direction. However, the looseness of our federal fiscal policy has placed an additional burden on monetary policy in our anti-inflationary fight, and led to tighter monetary policies than otherwise would have been necessary since the Bank of Canada seems to have been determined not to monetise the growing fiscal deficit and thereby exacerbate our inflationary situation. The fault, there-fore, lies mostly with our federal fiscal policies.
The authors suggest that the large fiscal deficit has been required because the private savings rate has been too high. [1] Their argument, however, ignores the potential impact of substantial federal government dissaving on personal and corporate savings rates. Accumulated government sector deficits lead to larger stocks of government bonds being held in private hands. But this addition to private sector wealth is offset by the present value of potential future tax liabilities. If the net effect of expanding government sector deficits is larger foreign borrowing, the second of these impacts may well dominate the first as far as the domestic economy is concerned. In consequence, higher private sector savings rates may themselves be caused by loose fiscal policies.
Whether or not this is the case, the real problem in Canada in the latter half of the 1970s is not high private savings rates. The problem has been an investment rate, and therefore a labour productivity growth rate. which has been too low. By increasing real (or inflation-adjusted) interest rates, federal fiscal deficits may have had strong crowding out effects on the volume of real investment expenditure.
Although Barber and McCallum argue for both a more expansionary monetary policy and an enlarged federal government deficit to reduce the Canadian unemployment rate, the consequences of any such policy combination would be to generate a higher rate of inflation. Unfortunately, we have placed our monetary-fiscal balance so out of whack that any further loosening of fiscal policy may well have perverse effects. Rather, we must make real progress towards reducing the federal government deficit and the associated substantial absorption of funds from the money market so that we can afford to reduce our real interest rates and perhaps thereby permit a slightly more expansionary monetary policy. This would increase the level of productive investment and (via keeping the exchange rate in the 84 U.S.( range) exports as well. The capacity-utilisation effects of maintaining the Canadian dollar in the 84 U.S.( range are clearly an important ingredient in an investment and productivity-orientated policy package.
The authors would keep the inflation rate in check by introducing wage subsidies or by resorting to wage and price controls. Wage subsidies do not seem to solve our stagflation problems, anymore than do indirect tax cuts. People are rational enough to realise that what is given with one hand has to be taken from someone with the other hand. The impact of a larger deficit to finance wage subsidy program is not going to increase confidence in our economic managers: indeed, its impact on the private savings-investment balance may well be perverse. Wage and price controls are best used only as a last resort in the case of a clear demand-side overshoot such as occurred in the 1973-75 period. They do not seem to have much going for them in the context of present-day stagflation. Any temporary beneficial effects that controls may have on the rate of inflation may be offset in the longer run by adverse effects on new investment demand, and hence on output, employment and productivity growth in the economy.
Despite these various points of disagreement, however, I strongly recommend the Barber/McCallum book to anyone interested in the inflation/unemployment dilemma in Canada. It is one of the best recent contributions to the solution of the difficult policy problems that stagflation forces upon us.
It remains, however, characteristically and unrepentently Keynesian in philosophical spirit.
1. They rightly point out that our balance-of-payments deficit on debt-service account, our government-sector deficit on interest-account, and our private-sector savings surplus on interest-income account all tend to be affected by the inflation premium embodied in nominal interest rates. Were appropriate inflation accounting applied to all of these numbers the extent to which they appear to have expanded relative to national or disposable income in the inflationary 1970s would be reduced considerably though of course sizeable changes would still remain.
Page revised: 1 January 2011
