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The following OECD assessment and recommendations summarise chapter 2 of the Economic survey of Canada published on 11 June 2008.
Monetary policy has changed direction
Up to and through most of 2007, monetary policymakers were primarily concerned with domestic inflationary pressures arising from rising commodity prices, strong domestic demand and tight labour markets. By the end of 2007, however, emphasis had shifted to managing Canada’s response to the global financial market turmoil, the associated tighter domestic credit conditions and to concerns about a slowing US economy, which led to substantial monetary policy easing. The main immediate challenge for monetary policy is to design the appropriate policy stance to keep inflation on target as the Canadian economy reacts to the US slowdown and global financial market turbulence. This may well involve some further easing. But when credit conditions return to more normal levels and the economy starts to recover, interest rates will need to increase. Regulators should also be reviewing whether steps need to be taken to ensure that institutional incentives in the financial sector are appropriate. Longer term, research is ongoing at the Bank of Canada and elsewhere to assess whether it should switch to a lower inflation target, and/or to price level path targeting. As the Bank has stated, the research would need to uncover compelling evidence in favour of a change to alter a regime that has proven successful.
Financial markets should be modernised
Further efforts by the Bank and other regulators are desirable to improve transparency, flexibility and competition in Canadian financial markets. The current diversity of regulations – for example, each province has its own securities regulator – makes it difficult to maximise efficiency, and increases the risk that firms will choose to issue securities in other countries. A single regulator would eliminate the inefficiencies created by the limited enforcement authority of individual provincial agencies. Also, the impact on economic growth from reducing competition restraining regulation in the banking sector could be significant. It is now time, ten years after the first merger proposals were blocked by government, to welcome competition in financial markets by allowing Canada’s leading financial institutions to become global players by lifting the ban.
Governments’ fiscal position remains solid but exposed to negative risks
Canada’s fiscal situation has improved significantly since the mid 1990s, as deficits were turned into surpluses and Canada’s public debt burden declined from the second highest to the lowest among G7 countries. This, combined with lower interest rates, has reduced debt service costs substantially over the past decade. Government’s size relative to the economy has shrunk, as shown by lower revenue, spending and net debt relative to GDP. However, current primary expenditures as a share of GDP have risen slightly since 2000. Over the next few years the combination of recent sizeable tax cuts and lower economic growth will eat into budget surpluses, raising the prospect of renewed small general government deficits, especially if lower commodity prices were to pare tax payments by the resources sector.
Governments should slow down their spending growth and strengthen expenditure control mechanisms
Over the last decade, the federal government and almost all its provincial and territorial counterparts have underestimated revenue on average, and have reacted by a combination of debt reduction, tax cuts and spending beyond levels announced at budget time. However, it is unlikely that recent growth rates in public expenditures are sustainable. Given the likelihood that the current slowdown in economic activity will curtail future favourable revenue surprises, all levels of government should avoid spending beyond originally budgeted levels. Furthermore, with the imminence of ageing pressures on spending, budgets should be subjected to serious continuing expenditure reviews. The major areas for the federal government to focus on are the level of subsidies, especially in agriculture (see below) but also transfers to lower levels of government. For their part, the provinces should redouble their efforts to ensure their spending is efficient, notably in health care.
Despite its relatively enviable fiscal position, Canada faces the same long term fiscal challenges related to population ageing seen in other OECD countries. The old age dependency ratio is expected to more than double over the next 50 years, putting significant pressure on public spending mainly through rising health care expenditures, since the earnings based public pension system has now largely been put on a sustainable footing. Among the policies that could help alleviate the problem are: more rigorous spending controls; programme and financing reforms aimed at improving the efficiency of public expenditures, especially in health care; faster debt reduction; shifting provinces’ taxation to more efficient bases; and, above all, growth friendly policies to help future generations afford the rising costs of government programmes.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.The complete edition of the Economic survey of Canada 2008 is available from:
For further information please contact the Canada Desk at the OECD Economics Department at firstname.lastname@example.org. The OECD Secretariat's report was prepared by Alexandra Bibbee, Yvan Guillemette, Shuji Kobayakawa and Annabelle Mourougane under the supervision of Peter Jarrett. Research assistance was provided by Françoise Correia.