I. Introduction ^1/

Previous reports have considered a number of important policy and economic issues, including those related to unemployment, the system of federal-provincial transfers, the public pension system, and fiscal deficit reduction (Table I-1). This report builds on this work and addresses some of the key policy and economic challenges facing the Canadian economy.

Table I-1.

Canada: Recent Staff Studies on Economic Issues and Policies

Table I-1.

Canada: Recent Staff Studies on Economic Issues and Policies

1. Recent Economic Developments (SM/92/25)
	a. The Natural Rate of Unemployment in Canada
	b. Fiscal Impulse Measures for Canada
2. Selected Papers on the Canadian Economy (SM/93/45)
	a. Labor Market Aspects of Industrial Restructuring in Canada
	b. Simple Measures of the Output Gap in Canada
	c. The Natural Rate of Unemployment in Canada Revisited
	d. A Forecasting Equation for the Canadian-U.S. Dollar Exchange Rate
	e. The Canada-U.S. Free Trade Agreement: A Retrospective on the Agreement and the Canadian Experience
	f. Balance Sheet Risk, Credit Supply, and Their Impact on Real Economic Activity
3. Economic Developments and Policies (SM/94/97)
	a. Federal-Provincial Fiscal Relations
	b. Aging Populations and Canadian Public Pension Plans
	c. Labor Market Policies
	d. Current Account Model
4. Recent Developments and Policies (SM/95/81)
	a. Estimates of the Structural Rate of Unemployment
	b. A Survey of Alternative Methodologies for Estimating Potential Output
	c. Federal-Provincial Transfers--A Review and Assessment
	d. Unemployment Insurance in Canada
	e. Public Support for the Elderly in Canada
	f. Illustrative Fiscal Policy Simulations

View Table

Table I-1.

Canada: Recent Staff Studies on Economic Issues and Policies

1. Recent Economic Developments (SM/92/25)
	a. The Natural Rate of Unemployment in Canada
	b. Fiscal Impulse Measures for Canada
2. Selected Papers on the Canadian Economy (SM/93/45)
	a. Labor Market Aspects of Industrial Restructuring in Canada
	b. Simple Measures of the Output Gap in Canada
	c. The Natural Rate of Unemployment in Canada Revisited
	d. A Forecasting Equation for the Canadian-U.S. Dollar Exchange Rate
	e. The Canada-U.S. Free Trade Agreement: A Retrospective on the Agreement and the Canadian Experience
	f. Balance Sheet Risk, Credit Supply, and Their Impact on Real Economic Activity
3. Economic Developments and Policies (SM/94/97)
	a. Federal-Provincial Fiscal Relations
	b. Aging Populations and Canadian Public Pension Plans
	c. Labor Market Policies
	d. Current Account Model
4. Recent Developments and Policies (SM/95/81)
	a. Estimates of the Structural Rate of Unemployment
	b. A Survey of Alternative Methodologies for Estimating Potential Output
	c. Federal-Provincial Transfers--A Review and Assessment
	d. Unemployment Insurance in Canada
	e. Public Support for the Elderly in Canada
	f. Illustrative Fiscal Policy Simulations

Chapter II presents a new approach to predicting the business cycle in the context of the Canadian economy. The conventional approach to predicting economic activity has been to use single equation models or atheoretical vector autoregressions that relate economic output to other economic and financial variables. This chapter suggests an alternative approach that uses a range of parametric and nonparametric tests to gauge the ability of various indicators to predict turning points in the business cycle. The results suggest that the slopes of the Canadian and the U.S. term structure offer reliable information regarding the future course of real GDP in Canada; monetary indicators, including the change in the nominal monetary conditions index and the change in real M1, are also helpful in predicting the cycle.

Price inflation in Canada has been moderate in recent years, raising questions about whether the effects of the exchange rate depreciation that has occurred since 1991 has already been fully reflected in domestic prices. Chapter III presents a model that links the inflation rate to the business cycle and the rates of change in the exchange rate and in unit labor costs. All three variables are found to systematically affect inflation. However, quantitatively, the most important determinant of inflation is the excess demand gap. Thus, the results suggest that the relatively low rate of inflation in recent years has been primarily due to the persistence of an excess supply gap in the Canadian economy and the decline in unit labor costs.

Sharp fluctuations in the exchange rates of the major currencies have led to a considerable volume of research on the issue of measurement of misalignments in exchange rates. Chapter IV describes one such measure of misalignment--the Fundamental Equilibrium Exchange Rate (FEER)--and notes that estimates of the FEER are subject to considerable uncertainty. In particular, the chapter concludes that in the case of the FEER for the Canadian dollar, the range of uncertainty is large enough to cast doubt on the usefulness of the FEER methodology for gauging exchange rate misalignments.

The downward trend in the personal saving rate in Canada since 1982 and its more recent decline in 1995 have raised concerns about the near-term prospects for domestic demand, primarily household consumption, and longer term concerns about the sufficiency of household saving to support investment and growth. Chapter V reviews recent trends in the saving rate and examines the factors that may have contributed to the recent decline. It concludes that the decline in the saving rate appears to be largely related to the transition to a low inflation environment since the early 1980s; saving rates that exclude the effects of inflation have been considerably more stable.

The generosity of the Canadian unemployment insurance system has been associated with a rise in structural unemployment, which, in turn, has led to a number of recent reform efforts. Chapter VI reviews the most recent proposals, which would tighten eligibility requirements by reducing benefits for previous claimants and increase funding for active labor market programs. This chapter cites evidence to suggest that, while the reform appropriately tightens eligibility requirements, there seems to be room for further action in the areas of repeat claimants and regionally extended benefits. In addition, the chapter suggests that active labor policies may be of limited effectiveness in promoting employment, especially given the adverse effects on employment of the payroll tax that funds these programs.

Demographic trends are expected to put substantial pressure on the fiscal situations of most industrial countries early in the next century. In the case of Canada, the share of the population that will be retired is expected to rise markedly after the year 2010, which will severely strain the finances of the public pension system--the Canada Pension Plan. Chapter VII presents estimates of the Plan’s unfunded liability and projections of the Plan’s finances over the next 55 years. The outlook shows that early action is needed to make substantial cuts in benefits or marked increases to contribution rates.

Much of the volatility in Canada’s financial and exchange markets during recent years has been ascribed to investor concerns regarding the high level of public sector indebtedness. Chapter VIII examines some of the key issues regarding the size and characteristics of federal and provincial debt, describes current management strategies, and discusses the risks regarding the maturity structure and currency composition of the outstanding stock of debt.

Chapters X and XI describe recent developments in Canadian trade policy and overseas developments assistance, respectively.