Gary Rabbior is the president of the Canadian Foundation for Economic Education. This is the first of a six-part series on understanding how the economy works and why it matters to investors.
At one point in time, there were some general agreements on what should be the goals for the Canadian economy. These goals were put forth by the Economic Council of Canada and were, for the most part, widely supported. The Council has long since disappeared however and there has not been much talk of what the goals are – or could be – for the Canadian economy since.
So, in the absence of any widespread, generally accepted goals for what we should be trying to do with Canada’s economy, let’s offer a few up as possibilities. If our economy is managed well, if our money and monetary conditions are managed well, and if our financial system works well, we would probably like our economy to:
• create and provide good quality jobs for Canadians, enabling them to earn incomes for themselves and their families and achieve a desirable standard of living,
• use resources wisely to produce goods and services efficiently that our citizens need and want
• use resources wisely to produce goods and services that are globally competitive and enabling us to sell exports and help boost the well-being of both Canadians and those who buy our exports
• increase the output of goods and services produced over time enabling us to create additional wealth to improve the well-being of all Canadians
• allocate the wealth produced in Canada in a fair and equitable manner
• provide social programs as needed to increase the ability of Canadians to achieve financial security – and to help those unable to attend to their own needs,
• factor into our economic decisions the impact our activities will have on our environment and the long-term quality of life of Canadians
• manage our resources and environment so that their availability and condition are equal to, or superior than, today’s for future generations
• provide opportunities for all Canadians to achieve a standard of living and quality of life that is consistent with what we, as a society, regard is an acceptable minimum level of well-being But achieving these outcomes is not an easy task. What about the means by which we will try to achieve those ends? There are many factors that will influence whether or not we can achieve these goals. Two of the more important factors, however, will be our ability to:
• achieve relatively stable prices over time and thereby protect the purchasing power of our money, and
• live within our means and avoid a debt burden that hampers the current, and future, growth and development of our economy.
The second factor is a topic for another series of articles. But the first factor really relates to our current focus – money and its role in the economy – and how to best manage the “money” that supports economic activity in Canada.
The primary responsibility for managing the “money” part of our economy falls to the Bank of Canada. The Bank of Canada believes that relative price stability is an important “means” to our desired “ends” (currently the Bank has set an annual inflation target of 2 per cent).
Let’s look more closely at this goal of “stability” – price and otherwise - for our economy. As has been shown by recent times, it is not easy to keep the economy on a steady course – and it is also hard to get it back on course once it is off it. Certainly over the past year or so our economy has not been on a nice, smooth, steady growth path. We have been through extraordinarily turbulent times. This has posed a real challenge for policymakers – including the Bank of Canada as it undertakes its role to try to create the right monetary conditions for growth and stability in our economy.
THE “CYCLE” OF ECONOMIC ACTIVITY: THE GOAL OF STABILITY
Therefore, as one can conclude from the economic times of 2008 and 2009, a major challenge for policymakers is to try to keep an economy stable – producing goods and services, creating and sustaining jobs and incomes, etc. Ideally it would be great if we could maintain a smooth course for the economy enabling it to grow moderately and persistently over time.
Unfortunately, this does not describe the usual path for economies. Such a path would be extraordinarily difficult to achieve—though policymakers keep trying.
Most economies experience good and not-so-good economic times as they move through cycles. There are periods of expansion (higher output – more goods and services) and contraction (lower output). There are periods during which the rate of inflation has been relatively high and others when it is relatively low. There have been periods of high unemployment and periods of low unemployment. Ups and downs. Good times and not so good.
No one needs to be told what kind of path we have been on lately. Economic activity has declined, output has fallen, unemployment has risen, and there has been widespread hardship as the economy has gone through a significant downturn. In fact, this downturn had a sense of “crisis” to it as the entire global economy turned downward. Many policymakers, economists, financial leaders, and others grew very nervous as to how bad things might get. Actions taken throughout the world appear to have moved us past a point of “crisis” to a path of recovery. But the economic path we have been on has been anything but smooth.
Policymakers have long tried to find the key to establishing a smooth path for the economy and avoiding such periods of downturn and decline. Various theories and policies have been developed and attempted. To date, no one has found the magic formula that will enable an economy to grow in a stable and continuing fashion over time without periods of slowdown, contraction, and relatively high unemployment alternating with periods of increased growth and rising price inflation. A Nobel Prize in Economics probably awaits the individual who finds the key—if it actually exists.
WHAT IMPACT DOES MONEY HAVE ON THE ECONOMY?
There are a variety of factors that will affect our economy’s path. Some are within our control – and some are not. A major factor within our control are the “monetary conditions” we create in Canada which will influence the path our economy takes and, ultimately, our success in achieving our goals. If monetary conditions are managed effectively, our chances of achieving our goals will be significantly improved. If not, we can suffer some pretty significant consequences such as wide fluctuations in the level of prices and employment and the performance of the overall Canadian economy.
If we have “too much money” in the economy, this can fuel spending to the point where our economy has trouble keeping up and, as a result, we can get rising inflation and rising interest rates. Rising prices and interest rates can slow down the economy and stifle investment and growth.
If we have “too little money” in the economy, this may not support the level of spending that a healthy economy needs and the lower spending, lower profits, and rising unemployment can lead to possible deflation – where the average level of prices starts to fall. Deflation is probably a more serious problem than inflation since it can lead to more trouble as people hold off buying assuming prices will fall further.
So getting the “money part” of our economy right is very important. The better the decisions are in terms of creating the “right” monetary conditions, the smoother our economic path can be. The challenge of those decisions lies with the Bank of Canada and, in the next article, we will begin our exploration of the relationship between money, monetary conditions, and the economy with an analogy, a game we’ll call “Auction Block.”