Macroeconomics: Canadian Monetary Policy Article Summary Report

This report summarizes Pierre Fortin's article, "Interest Rates, Unemployment and Inflation: The Canadian Experience in the 1990s," which critiques Canada's monetary policy during that decade. The article highlights how the slowdown of the US economy in the early 1990s affected Canada, and examines the loopholes within the Canadian economic system. The author focuses on unemployment and inflation, arguing that high lending rates, coupled with unemployment and low inflation, hindered economic performance. The article suggests the need for specified inflation targets and effective coordination between fiscal and monetary policies, pointing out the negative impacts of the Bank of Canada's actions, including the underestimation of the negative effects of high interest rates. The report highlights the lack of responsiveness of the Bank of Canada and its reliance on mechanical trend-fitting techniques, which magnified the impacts of the economic slump. The summary emphasizes the need for flexible monetary policies that adapt to changing economic, political, and social environments and the importance of critical evaluation of past judgements by the banks.

MACROECONOMICS
ARTICLE SUMMARY

The following work is an attempt to summarise the article namely “Interest Rates,
Unemployment and Inflation: The Canadian Experience in the 1990s,”by the author Pierre
Fortin. The author in his work provides a critique of the monetary policy of Canada, back in
the 1990s. The said critique work has been developed by the author over a decade of
observations. The main theme of the article is that owing to the slowdown in the early 1990s
of the US economy the growth of Canada has also slowed down. However, the author points
out the loopholes in the Canadian economic system leading to the inferior performance of the
Canadian economy. The review is mainly concentrated on the unemployment and the
economic inflation factors of the Canada economic performance.
In the initial part of the article, the article sheds light on the inflation and the unemployment
statistics of Canada in comparison to the performance of other OEC countries. One of the
chief points highlighted in the work that had formed the base for the said economic distress is
stated to be the monetary mechanism. It has been stated in the work that the period had
witnessed a consistent fall in the Canadian Dollar exchange rate, par below the US rate. The
effect was further aggravated by the high unemployment rates in the economy over the period
of six years. It has been argued by the writer that there were high lending rates prevailing in
the country, together with unemployment but a contrasting low inflation rate in the market.
Thus, the author is suggestive of enhancement of the monetary conditions. Further, the rise in
the lending rate and exchange rate of Canadian dollar also led to the marring of the aggregate
spending and output, which lowered down the exports for the entities and thus the profits. It
is suggested by the author that it is imperative for the economies to set a specified inflation
target for the conducting of a monetary policy. The step not only lead to the stabilization of
the inflation but also indicates to the public and the organisations the objective of the
monetary policy of the government. Thus, there can be stated to be conflicting aims in
context of the low employment and the low inflation. It has been pointed out that the first half
of the decade had not performed well in terms of the economic performance, as characterised
by the rate of inflation plunging down at the faster rate than was expected by the government.
The main culprits of the same are stated to be the all levels of the government being exposed
to the fiscal issues. The Bank of Canada had made severe attempts to bring the interest rates
down, however the international developments, nervousness in the markets and domestic
political situations led to the failure of the said attempts. Thus, the attention has been laid
down on the fiscal policy of the government as well. The year 1988 had already started to
witness the increment in the debt-service costs, the rise in social expenditures, rising risk

premiums, distressed financial markets, the fall in fiscal revenue, were the outcomes of the
high interest rates as were set by the Bank of Canada. The comparison of the economic policy
of the US reveal that the authorities in the US had stabilized the real short term interest rates
on a very lower side and thus were able to face the financial crisis efficiently. As a result of
the same, the public sector of the Canada had been deeply impacted. Thus, from the data
presented above, it is clearly evident that there was a severe lack of coordination between the
fiscal-monetary Canadian policies. In addition, it has been pointed out that the same period
has also witnessed a number of sensitive reforms in the form of privatization, tax changes,
deregulation, allowance of free trade and others. The simultaneous developments prevented
the authorities to concentrate on the monetary policy. Thus, the policy coordination had
lacked for Canada during the period. Thus, it must be significantly noted that though the roots
of the recession lie in the stock market crash of the 1980s, followed by the savings and loan
crises, yet the inefficient monetary policies and the coordination magnified the impact of the
economic slump. Thus, it is crucial to note that the free trade agreement with the US led
serious impacts of the US recession to Canadian economy as well.
The later part of the article is focussed on the unemployment issues during the period. It has
been highlighted that the actual output of the economy had fallen short of the targeted output.
Yet again the attention has been pointed on the fact that the Bank of Canada was not
responsive enough and underestimated the negative effects of high interest rates on
consumption and investment. This was in combination of the over expectation on the net
exports of the favourable effects of the exchange rate depreciation. The difference between
US Federal Reserve lies in the fact that there were positive output gaps estimated by the Bank
of Canada. However, no such fear has been seen in the US Council of Economic Advisers or
the US Federal Reserve. To respond to the above set of the unestablished conditions, the bank
had applied the mechanical trend-fitting techniques. However by this time the impacts had
already magnified and led to the deflationary bias to Canadian monetary policy. Thus, the
laid back and an overall reactive rather a proactive approach of the Bank of Canada has been
pointed out very significantly in the work.
The reasons for the lower inflation targets have been highlighted in the work to be that Bank
of Canada has already set the official target at a lower base. Further, the rate could not even
reach the official target and was on lower side than that. Further, the article highlights the
effect of downward nominal wage rigidity resulting in the low inflation environment. The
inflation rate has been further evaluated in the light of the non-accelerating-inflation rate of

unemployment (NAIRU). According to the said framework, a central bank of the country can
address the increased inflation by the simple increasing the actual unemployment above the
NAIRU. However, the bank failed to address the said issue of inflation and refused to get past
the initial judgements made in context of the economic conditions. The key outcome of the
said irrationality is the nominal wages being set higher in absolute term. As a result of which,
there would be increase in the inflation leading to the increment in the permanent level output
and employment. Thus, the economy of the Canada has experienced a great deal of
unnecessary and costly excess unemployment. Thus, the rigidities in the attitude of the
government in the Canadian context is quite evident. In addition to the above factors stated it
must be noted that there were serious difficulties leading to the management of aggregate
demand by the Bank of Canada become complex.
The main theme of the summary can be stated to be overly low target being set by the
government, and following the same judgement blindly. Thus, from the discussions
conducted in the previous parts in the form of the summary of the mentioned article facilitate
to conclude that an efficient monetary policy is at the heart of the economy of any country.
Further, it can be concluded that stance of the policy has to be changed as per the events
taking place in the economic, political and social environments, and as per the change in the
rate of inflation. It can be rightly concluded that the banks must take proper care in the
expressing of the views of the future monetary developments in the country. Further, the
authorities must be critical of evaluation of the judgements in the past. For instance, in the
Canadian context, the Bank of Canada had made an assertion about its judgement about the
monetary policy and the future expected conditions. However, it failed to adjust its
judgements to the unexpected economic shocks, and series of delicate and unforeseen events.