Front Matter

Front Matter

Author(s):
Vladimir Klyuev, Martin Mühleisen, and Tamim Bayoumi
Published Date:
October 2007
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©2007 International Monetary Fund

Production: IMF Multimedia Services Division

Typesetting: Julio R. Prego

Figures: Bob Lunsford

Cataloging-in-Publication Data

Northern star : Canada’s path to economic prosperity / edited by Tamim Bayoumi, Vladimir Klyuev, and Martin Mühleisen. — Washington, D.C. : International Monetary Fund, 2007.

  • p. cm.—(Occasional paper ; 258)

Includes bibliographical references.

ISBN 978-1-58906-614-4

1. Canada — Economic conditions — 1991–2. Canada — Economic policy. 3. Fiscal policy — Canada. 4. Monetary policy — Canada. I. Bayoumi, Tamim A. II. Klyuev, Vladimir. III. Mühleisen, Martin. IV. International Monetary Fund. V. Series: Occasional paper (International Monetary Fund) ; no. 258

HC115.N678 2007

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Contents

The following conventions are used in this publication:

  • In tables, a blank cell indicates “not applicable,” ellipsis points (…) indicate “not available,” and 0 or 0.0 indicates “zero” or “negligible.” Minor discrepancies between sums of constituent figures and totals are due to rounding.
  • An en dash (−) between years or months (for example, 2005–06 or January–June) indicates the years or months covered, including the beginning and ending years or months; a slash or virgule (/) between years or months (for example, 2005/06) indicates a fiscal or financial year, as does the abbreviation FY (for example, FY2006).
  • “Billion” means a thousand million; “trillion” means a thousand billion.
  • “Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).

As used in this publication, the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.

Preface

Two decades ago, Canada was running current account deficits and its fiscal situation looked dismal. While inflation had come down from double digits, it remained in the 4–5 percent range, the unemployment rate was above 8 percent, and GDP growth was erratic. Gloom permeated assessments of Canada’s economic prospects.

Facing up to the challenges, Canadian authorities undertook an impressive set of reforms to set the economy on the right course. Tax reform, tight expenditure control, as well as an explicit fiscal framework that focused on reduction and, subsequently, elimination of the deficit have turned the fiscal situation around. Pension reform has put the Canada and Quebec Pension Plans on a sustainable track. An inflation targeting (IT) framework, which Canada was the second in the world to introduce, has anchored inflation expectations and made monetary policy more predictable. The Canada-U.S. Free Trade Agreement, followed by the North American Free Trade Agreement (NAFTA), opened the economy to more foreign competition. This was accompanied by an agreement on internal trade and other measures to make the economy more flexible.

As a result, the economic situation now looks dramatically different. The stop-and-go cycle is a thing of the past. Inflation has averaged 2 percent since December 1995, when that number was adopted as the target in the IT agreement. The unemployment rate is at a 33-year low, and real GDP growth has been among the fastest in industrial countries during the last 10 years. The federal budget has recorded nine surpluses in a row, and general government debt is trending down. The current account has been in surplus since 1999. The new framework has dramatically improved macroeconomic stability, with variation in GDP growth, inflation, and interest rates much lower than previously. While the performance of many industrial countries has improved, Canada’s improvement has been particularly dramatic.

This improvement has occurred despite a series of major shocks, including the emerging market financial crises of the 1990s; the collapse of the dot-com bubble later in the decade; the September 11, 2001, terrorist attacks on the United States; outbreaks of SARS (severe acute respiratory syndrome) and mad cow disease (bovine spongiform encephalopathy, or BSE); growing competition from the rising Asian economies, particularly China; and wide fluctuations in commodity prices. The Canadian economy has exhibited remarkable resilience in the face of these challenges. In particular, the economy has adjusted extremely well to the recent run-up in energy prices and the exchange rate, which has put differential pressures on regions and sectors, boosting the resource-rich western provinces and squeezing manufacturers in central Canada.

Despite the successful record, challenges inevitably remain. Population aging and the rising cost of medical services are putting pressure on government finances, and reining in health care costs remains an important challenge, which is by no means unique to Canada. While safe and sound, Canada’s financial sector may lack dynamism—possibly reflecting a regime that effectively precludes takeovers from home or abroad. Marginal tax rates on investment are among the highest in the world, which may help explain why the rise in productivity has been less striking than for real GDP.

The IMF enjoys a close working relationship with the Canadian authorities and has been highly supportive of Canada’s strong institutional framework and continuing structural reforms, just as the Canadians have provided the IMF with much useful insight on its own future direction. This volume collects analyses of various aspects of the Canadian economy undertaken by IMF staff members in recent years. Strikingly, despite its economic size, Canada features many characteristics of a “small open economy”—it is relatively open; its trade is highly concentrated with the United States, making it susceptible to economic fluctuations in its southern neighbor; and it is subject to the vicissitudes of global economic conditions by virture of its large commodity exports. Canada’s success in facing challenges common to many other IMF member countries can thus provide valuable lessons to a wide range of academics and policymakers.

This paper has benefited from the comments of colleagues in the Western Hemisphere Department (WHD) and in other departments of the IMF. In particular, the editors appreciate the contributions of Charles Collins and Christopher Towe. The editors are also grateful for the assistance of Alfred Go, RoseMarie Elizabeth Fonseca, Eneshi Irene Kapijimpanga, and Volodymyr Tulin in the WHD department. Linda Griffin Kean of the External Relations Department edited the manuscript and coordinated the production of the publication. The views expressed in this paper are those of the IMF staff and do not necessarily reflect the views of national authorities or IMF Executive Directors.

Abbreviations

bbl

barrel

BLS

Bureau of Labor Statistics (U.S.)

BSE

bovine spongiform encephalopathy (mad cow disease)

CAPP

Canadian Association of Petroleum Producers

cf/bbl

cubic feet of natural gas per barrel of oil

CPI

consumer price index

CPP

Canada Pension Plan

CPPIB

CPP Investment Board

DD

distance to default

EI

Employment Insurance

EUB

Energy and Utilities Board (Alberta)

FIRE

finance, insurance, and real estate

GDP

gross domestic product

GEM

Global Economic Model (IMF)

GFM

Global Fiscal Model (IMF)

GIS

Guaranteed Income Supplement

GMM

generalized method of moments

GPO

gross product originating (by industry)

GST

Goods and Services Tax

HP

Hodrick-Prescott

ICT

information and communication technology

IO

industrial organization

LBG

large banking group

mb/d

million barrels a day

MCI

Monetary Conditions Index

MST

Manufacturers’ Sales Tax

NAFTA

North American Free Trade Agreement

NAICS

North American Industry Classification System

NEB

National Energy Board

OAS

Old-Age Security

OECD

Organization for Economic Cooperation and Development

OLS

ordinary least squares

OPEC

Organization of the Petroleum Exporting Countries

OSFI

Office of the Superintendent of Financial Institutions

PEM

public expenditure management

REER

real effective exchange rate

ROSC

Report on the Observance of Standards and Codes (IMF and World Bank)

RPP

Registered Pension Plan

RRSP

Registered Retirement Savings Plan

SARS

severe acute respiratory syndrome

SGP

Stability and Growth Pact (EU)

SIC

Standard Industrial Classification

SME

small and medium-size enterprise

SPA

Spousal Allowance

TFP

total factor productivity

TPSP

tax-prepaid savings plan

VAR

vector autoregression

WEO

World Economic Outlook

WTI

West Texas Intermediate

YBE

yearly basic exemption

YMPE

yearly maximum pensionable earnings

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