A good economic stimulus plan needs to fit the times to respond to the current economic context.
This document provides background for a discussion on potential initiatives to stimulate Canada's economy.
It raises three main points:
- Economic growth in Canada has slowed.
- Fiscal and monetary policy can play important roles in supporting a recovery.
- The key challenge is choosing timely and well-targeted stimulus.
In the coming weeks, the Government will consult broadly on a well-designed fiscal stimulus plan for Canada.
The Government is open to new innovative ideas that would form the plan for economic recovery in the 2009 Budget.
Potential examples include:
- Expediting infrastructure projects.
- Investing in housing.
- Supporting workers and sectors affected by the economy.
- Improving access to credit.
The Government is working with all its partners to table a plan for economic recovery on January 27, 2009, the earliest budget in Canadian history.
To date, Canada has performed better than any G7 country.
However, the weakening global economy has reduced GDP growth in Canada over the past year.
Private sector forecasters are now widely expecting a recession with negative growth in the fourth quarter of 2008 and the first quarter of 2009.
A rising Canadian dollar and the U.S. slowdown have led to job losses and reduced output in export-intensive sectors, particularly manufacturing and forestry.
In the current economic context, fiscal stimulus would complement monetary policy – which has helped ease borrowing rates – and support the economic recovery.
The weakening in the Canadian economy has begun to weigh on the labour market.
After bottoming out at 5.8 per cent in February 2008, the unemployment rate inched up to 6.3 per cent in November 2008. Nevertheless, Canada's unemployment rate remains low by historic standards.
With job losses concentrated in certain sectors, some provinces have experienced larger increases in unemployment than others. Ontario, with its large manufacturing and auto sector, has been particularly hard hit. The unemployment rate in that province has risen from 6.1 per cent in February to 7.1 per cent in November 2008.
The Government and the Bank of Canada have a number of tools at their disposal to support economic growth.
These include monetary policy, measures to support Canadian credit markets, and fiscal policy actions through lower taxes or higher targeted spending, such as infrastructure investment.
The Government and the Bank of Canada have been actively using all of these tools. In the current environment, fiscal policy should continue to complement monetary policy and measures to support credit markets in order to promote an economic recovery.
In response to the global financial market crisis, the Bank of Canada has aggressively reduced interest rates.
The Bank of Canada has cut its target rate by 300 basis points since September 2007.
This has reduced borrowing costs for households and businesses, and provided significant stimulus to the economy.
An interest rate cut of 100 basis points can be expected to increase output (GDP) by 0.5 per cent after one year, or roughly $8 billion.
The Government and the Bank of Canada have also introduced a number of measures to ensure Canadian businesses and families continue to have access to affordable credit.
The Bank of Canada has added more than $35 billion in liquidity to the Canadian financial system at a time when global credit markets have been severely stressed.
The Canada Mortgage Bond (CMB) program has been expanded, including a record $12.5-billion CMB issue in June, and the introduction of a new 10-year CMB issue of $2B in November. The Government is supporting the availability of longer-term credit in Canada by purchasing up to $75 billion in insured mortgage pools under the Insured Mortgage Purchase Program (IMPP).
The Canadian Lenders Assurance Facility will ensure that Canada's financial system is not put at a competitive disadvantage by similar guarantee programs in other countries.
On the tax front, much has already been done. Canadians and Canadian businesses will pay $31 billion less in taxes in 2009-10 – tax relief of almost 2 per cent of GDP – thanks to tax reductions implemented by the Government since 2006.
Several other advanced countries have taken fiscal stimulus measures. But unlike the measures taken to date in Canada, theirs are mostly temporary.
For example, the temporary fiscal stimulus provided by the U.S. administration in 2008 will fall off greatly in 2009. To avoid a negative impact on growth, this stimulus would need to be renewed. In contrast, Canada's tax reductions implemented since 2006 will continue to grow next year and beyond.
The Government has delivered stimulus through significant tax reductions since 2006, providing tax relief to Canadians of $31 billion in 2009-10.
The Government has reduced the lowest personal income tax rate from 16 per cent to 15 per cent. The corporate income tax rate will fall to 15 per cent by 2012 from 22.12 per cent (including the corporate surtax) in 2007. We have cut the GST by two percentage points.
There is also a role for provinces to play in building a more competitive tax system. The Government is encouraging them to reduce their general corporate income tax rates to 10 per cent by 2012.
In addition, replacing harmful retail sales taxes with a value added tax harmonized with the GST will reduce taxes on business inputs for our manufacturers.
In Budget 2007, the Government announced a seven-year, $33 billion plan to fund projects such as roads and highways, public transit, bridges and sewers.
Federal funding for infrastructure in 2009 will rise to a record $6 billion–double what it was last year.
The Government is taking steps to do more.
In the coming weeks, the Government will work with provinces and territories to expedite priority infrastructure projects in time for the coming construction season.
Fiscal stimulus can take the form of tax reductions and government spending. But what is required for an effective fiscal stimulus plan?
It should boost the economy when needed, not when it has already recovered.
Each dollar of stimulus should deliver the maximum impact here in Canada.
If the recession is longer or deeper than anticipated, the stimulus will need to be larger and longer in duration.
An effective stimulus should also balance our short term needs with our long term economic plan for prosperity.
Timely fiscal measures stimulate new spending quickly so businesses do not have to cut back as much on production or lay off as many workers due to weak demand.
This ensures the benefit occurs in the short term, when the economy needs it.
Although infrastructure projects, such as roads and bridges, can take a long time to get started, some projects can be brought ahead in time for the coming construction season.
Projects that are ready to go can be expedited, while repairs and necessary maintenance can be performed on existing infrastructure.
Canada is committed to the global effort to provide fiscal economic stimulus. But we should ensure our actions have the maximum impact here in Canada.
This impact is lost when fiscal stimulus is not spent (i.e. it is saved or used to pay down debt) or is used to buy imported goods and services.
For example, only about 30 per cent of the U.S. tax rebate cheques mailed out in 2008 were spent by U.S. consumers.
Canada is a major importer of goods. In total, we import 27 per cent of goods we consume. This rises to 50 per cent for durable goods.
In contrast, only 20 per cent of investment in residential and non-residential buildings is imported through such inputs as building materials.
Consequently, stimulus directed at domestic activities, like construction, is more effective in boosting growth here in Canada.
Given the current uncertainty with respect to the extent and duration of the global slowdown and its impact on Canada, an important consideration is the size and duration of the stimulus.
While the fiscal actions must stimulate the economy through the coming difficult period, they should not burden Canada with a structural deficit that hampers growth in the years ahead.
Canada's long-term economic plan is to improve productivity through education and skill development, investment in new capital and technologies, and innovation.
An important consideration in designing effective stimulus policies is balancing these long-term goals with our short-term needs.
Certain policies that boost long-term growth will have a smaller impact in the short run, and vice versa.
However, some fiscal actions can stimulate growth in the short and long term.
For example, investments in infrastructure and training will boost economic activity in Canada next year and contribute to long-term growth in productivity and living standards.
Canada needs a well-designed fiscal stimulus plan that boosts the economy now, but will not burden Canada with a structural deficit that hampers growth in the years ahead.
To ensure maximum impact, it will be important that all provinces and territories, Canada's G20 partners and other countries also stimulate their economies.
The following four criteria are important considerations in designing effective stimulus policies:
To ensure it strikes the right balance in its stimulus plan, the Government of Canada will consult broadly with Canadians, with the provinces and territories, stakeholders and political parties over the coming weeks with a view to introducing a budget on January 27th 2009.- News Release 2008-103 -