Financial Crisis in Canada - Assignment Example

In our work we are going to present how the Canadian economy changed under the pressure of the ongoing financial crisis. We will briefly go through the period before the crisis. Afterwards the consequences of the crisis on the economy will be presented together with the decisions that the central government made as well as describe the moves of the Central Bank of Canada. We will try to show what effects that had (fiscal and monetary moves) if any on the situation that was being faced. At the end we will present the current situation in Canada.

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‘Canadian banks have been relatively resilient to the ongoing credit turmoil. The effect of the turmoil on the Canadian financial system is, so far, milder than in other G7 economies. Interbank money markets remained functional. No injections of public capital into banks were necessary. The resilience appears particularly striking given the close economic and financial links between Canada and the United States’[1]

Canada has announced: • cuts in personal income taxes • increase spending on infrastructure in the form of direct central government spending, and through capital transfers to local authorities. • protect liquidity-constrained or vulnerable groups, including by strengthening unemployment cash transfers, including to the poor and pensioners • setting up support for small- and medium-sized enterprises such as construction. • address longer-term policy challenges, such as improving the quality of health and education and introducing incentives for development of environmentally friendly.

Economic History of Canada

Since World War II, Canadian economy has experienced very important changes. During the conflict, unemployment virtually disappeared, mainly because of the recruitment of soldiers, and industry turned to war production.

After the war, Canada was able to maintain and expand the growth and development of it`s economy. Unemployment levels remained low, and wartime production was quickly turned over to making consumer goods. Canada also signed the Bretton-Woods Agreement that consisted on establishing a postwar international monetary system of convertible currencies, fixed exchange rates and free trade.

Canada was successful establishing itself as a welfare state. For example, in 1957 Public Medical Care Access was established. During those 25 years after the war, Canada experienced an immense economic growth. One of the points of this economic development was the fact that Canadian economy became much closer to United States one. This was possible thanks to the fell of tariff barriers and the sign of trade agreements like the Canada-United States Automotive Agreement or the Hyde Park Declaration.

Canadian economy and development were focused on some specific sectors that finally became the main industries of the country such as Transportation Equipment, Chemicals, Processed and Unprocessed minerals, Wood and Paper products or natural resources as Petroleum and Natural Gas.

After that 25 years period of high growth, Canada experienced high inflation rates during 1974 and 1975 that were solved with the Anti-Inflation Act of 1975 that in the following years reduced the CPI from 11% approx. to lower levels as 2-3%.Also Canada suffered economic recession in the early 1980`s and again in the early 1990`s. These recessions led to government deficits, high unemployment levels and general disaffection. Although there was a brief recovery in 1994, it was followed by a new slump in 1995-1996.

Another important point of Canada`s economic development was the sign in 1989 of the Canada-United States Free Trade Agreement which was followed by the creation of the NAFTA (North-American Free Trade Agreement), that included Mexico. NAFTA created the largest free trade area in the world, covering 360 million people and nearly $500 billion in yearly trade and investment.

Since 1996-1997, Canada`s Economy has improved markedly, thanks also to the recovery and later boom of the United States. Services Sector became the most important of the country, employing almost 75% of the working population and contributing approximately with the 60% of the GDP. However, Canada has not had a uniform development. Some regions, for example Ontario , are richer than others , provoking extreme situations as a referendum for sovereignty in Quebec in 1995 that was not successful.

It is important to say that the Health Care System, called Medicare, is financed by General Government Revenues , and has became the largest component of Canadian Provincial Budgets.

In 2000 , Canada avoided following the US into a recession caused by the collapse of the dot com bubble(a speculative bubble during which stock markets in Western Nations saw their equity value rise rapidly from growth in the more recent Internet sector). Following this downturn, Canadian economic growth has been concentrated in the petroleum, real estate and income trust sectors. Now we are going to explain the fiscal policies of the last 20 years. During the last 20 years the Government of Canada has made some economic policies that were largely influenced by two goals: – Eliminating the federal deficit and reducing the total debt relative to economic output – Maintaining control over inflation.

“In pursing these goals, the federal government largely abandoned an activist Keynesian approach to fiscal policy, particularly in the 1990s and the early years of the new millennium. The government’s new approach was based on the premise that sustained economic growth and low unemployment is best achieved through controlled levels of inflation, relatively low interest rates, and healthy government finances (Grady, 2009). Fiscal policy, therefore, no longer emphasized direct stabilization of the economy through expansionary and contractionary tactics.

It focused, instead, on creating an environment for sustainable economic growth through the elimination of the deficit and the reduction of the debt relative to economic output.”[2] The goal of the fiscal policies was to return the nation´s finances to health. In the 80´s, the federal government introduced a number of tax and expenditure controls to try reduce the deficit of the country. However, these regulations were deleted in the early 90´s because Canada (as it is described above) went into recession, producing a decrease in the tax revenues.

During 1995 the new government introduced a series of tough budgets, that were major expenditure cuts. As a result, the federal government achieved a balanced budget in the fiscal year 1997-98, the first one in nearly 30 years. These budget surpluses have been the base of the economy for the next years. With these budget surpluses the government allocate those resources in: – Increased spending (in particular, on social programs) – Tax reductions

– Debt reduction. The greatest portion of the surplus was oriented towards increased spending. Later, with the election of a new government (2006), they focused more on tax reduction using those budgetary policies. In 2006 and 2007, the federal government announced significant tax cuts, including a reduction of the federal Goods and Services Tax (GST) from seven to five percent. And we are going to say just a few words about the history of the monetary policies in Canada. In the 1960s and early 1970s, the Keynesian approach was dominant in monetary and fiscal policy was dominant.

But, “the low-inflation policy of the Bank of Canada in the 1990s rekindled dispute between Keynesians and monetarists. That dispute will finish shift the inflation rate to an average of 2% or less, arguing this laid the foundation for strong future Canadian growth”.[3] With the federal budget of 1991 the then Conservative government and the Bank of Canada jointly agreed on a set of inflation-reduction targets as a cornerstone of both monetary and fiscal policy. An inflation target of 1-3% for 1995-98 was subsequently reaffirmed by Bank of Canada and the Liberal government elected in 1993.

Why Canada resisted better to the crisis than other world major economies?

Canada’s financial system has been considerably less affected by the current global crisis than many other industrialized countries such as Great Britain. The WEF (World Economic Forum) has ranked Canada´s banking system as the soundest in the world. Canadian banks are profitable, well –capitalized and well positioned to resist economic shocks. As well, the banking system is relatively stable.

Moreover, the regulatory structure for Canada´s financial sector is both more responsive and more prudent. Furthermore Canadian banks were less active in the sub-prime lending and secularization activities, which are the most important facts of the current financial crisis. (i.e. In 2006 sub-prime loans accounted for less than 5% of new mortgages in Canada, compared to the 22% in the United States. 75% of Canadian mortgages were held by financial institutions on their balance sheet in a more traditional way).

Although, the Canadian financial system seems to be doing better than those other countries, Canada´s economy nevertheless feeling the global economy slowdown. The economic difficulties experienced by their largest partner (United States) are weakening Canadian exports and manufacturing sector. Moreover, the strong Canadian energy and natural resources sector is likely to suffer as the world economic slowdown causes a lower demand and weaker prices for commodities. Although Canada has been isolated from the worst of the financial crisis to date, the impact of the economic slowdown in the United States and elsewhere has affected and will continue to affect this nation.