====================================================================== Note: The electronic version of the following Appendix G is for informational purposes only. The printed version remains the official version. All tables have been placed at the end of the file. ====================================================================== APPENDIX G THE IMPACT OF RECENT MONETARY POLICY ON THE BRITISH COLUMBIA ECONOMY INTRODUCTION The Government of British Columbia is concerned that federal monetary policy has been too narrowly focused on the objective of zero inflation. While this policy appears to have reduced inflation, it has done so at the cost of thousands of Canadian jobs and lost output that will never be recovered. Combined with other policies such as the introduction of the goods and services tax and the implementation of the Canada-U.S. Trade Agreement, recent monetary policy has done considerable damage to the economy. Several public policy research organizations and people in the academic community participated in the debate over whether tighter monetary policy was desirable. Most of this debate occurred before the full effects became visible. Now that low inflation appears to have been achieved, public policy commentators have moved on to other topics. The Government of British Columbia felt that there should be some quantification and evaluation of the impact of the zero-inflation policy if similar policy errors are to be avoided in the future. Therefore, the government engaged WEFA Canada, a prominent economic forecasting and consulting firm, to conduct a study of the impact of recent monetary policy on British Columbia. The methodology and results of the WEFA Canada study are outlined below. SUMMARY OF MONETARY POLICY STUDY BY WEFA CANADA There has been a significant deterioration in the performance of the economies of British Columbia and the rest of Canada over the past few years. This poor performance has led to a search for explanations for the economic slowdown. Many observers have pointed to the "excessive" tightness of monetary policy resulting from the Bank of Canada's attempt to reduce not only cyclical inflation, but also to reach its goal of zero inflation as a major factor behind the slowdown. The purpose of this study was to examine the impact of the Bank of Canada's tight monetary policy on the British Columbia economy since 1988. The study reviews the recent performance of the British Columbia economy and Canadian monetary policy. Economic growth has fallen sharply over the past couple of years, the unemployment rate has risen, and the government deficit has increased. Inflation rose until 1992, when it fell sharply in response to the Canadian recession. The stance of monetary policy over the past few years may be characterized as very restrictive. In fact, by some measures, monetary policy appears to have been more restrictive than in the recession of the early 1980s, and more restrictive than recent monetary policy in the United States. The methodology adopted to examine the impact of the Bank of Canada's policy on the British Columbia economy was to conduct an econometric model simulation that incorporated an easier monetary policy. The easier monetary policy is one that leads to movements in Canadian interest rates that are similar to those in the United States over the 1988-91 period. This was done by holding the gap between Canadian and U.S. short-term interest rates at two per cent (see Chart G1). The simulation was conducted using the WEFA Canada WCCM model and the provincial government's econometric model of the British Columbia economy. The results of the simulation were compared against the actual performance of the economy for this period. The results of the study suggest that tight monetary policy is an important factor explaining the deterioration in the performance of the British Columbia economy over the past few years. An easier monetary policy would have led to a much higher level of GDP and a significantly lower rate of unemployment. While these aspects of economic performance would have been improved under an easier monetary policy, inflation would have been higher. With an easier monetary policy, real GDP in British Columbia would have been almost 5.0 per cent higher in 1991, which represents an additional $3.2 billion of inflation-adjusted production. The unemployment rate would have been about 3.0 percentage points lower in 1991 while 52,000 more people would have been employed. Inflation, in contrast, would have been over 2.0 percentage points higher in 1991. A major impact of monetary policy has been to increase government deficits and debt. Lower revenues and increased expenditures associated with a tightening in monetary policy have caused the federal and provincial deficits to increase. The benefits to the provincial treasury of an easier monetary policy would have been a $1.3 billion lower deficit and $3.0 billion less debt in 1991. --------------------------------------------------------------------------- TABLE G1 IMPACT OF AN EASIER MONETARY POLICY ON THE BRITISH COLUMBIA ECONOMY --------------------------------------------------------------------------- 1988 1989 1990 1991 Total* --------------------------------------------------------------------------- Real GDP (percentage change) Actual ........................ 5.2 4.7 2.8 0.0 Easier Money................... 5.9 6.4 4.9 2.1 Difference..................... 0.6 1.7 2.1 0.4 4.7 Employment (percentage change) Actual......................... 4.0 5.7 2.4 1.4 Easier Money................... 4.3 6.8 4.0 1.9 Difference..................... 0.3 1.2 1.6 0.5 3.6 Difference (000s persons)...... 3 19 43 52 Unemployment Rate (per cent) Actual......................... 10.4 9.1 8.3 9.9 Easier Money................... 10.1 7.9 5.7 7.1 Difference..................... -0.2 -1.2 -2.5 -2.8 CPI Inflation (per cent) Actual......................... 3.6 4.5 5.5 5.3 Easier Money................... 4.2 6.0 7.5 7.8 Difference..................... 0.6 1.5 2.0 2.5 Provincial Government Budget Balance Economic Accounts Basis ($ millions; - indicates deficit) Base........................... 628 986 900 -449 Easier Money................... 803 1,490 1,925 810 Difference..................... 175 504 1,025 1,259 2,963 * This is the cumulative impact over the 1988-1991 period on the economic indicator in level terms. For example, by the end of 1991, real GDP under an easier monetary policy is 4.7 per cent above its actual level. Source: WEFA Canada. --------------------------------------------------------------------------- Copies of the WEFA Canada study The Impact of Recent Monetary Policy on the British Columbia Economy can be obtained by writing to: Communications Branch Ministry of Finance and Corporate Relations Room 109, 617 Government Street Victoria, British Columbia V8V 1X4