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Canada’s track record on growth and budget position tops Group of Seven

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 2005
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For almost a decade, Canada has recorded the fastest economic growth and strongest budget position of the Group of Seven (G-7) major industrial countries. Since 1995, Canada’s real GDP growth has averaged 3½ percent a year—2½ percent on a per capita basis—narrowing the gap with the United States and remaining well above most other G-7 countries. Moreover, the country has kept its fiscal accounts in balance, which helped reduce the net debt ratio by almost 35 percentage points of GDP.

What lies behind this strong track record? The answer is twofold: a strong institutional framework, which is based on inflation targeting and a strong commitment by the federal government to maintain balanced budgets or better, and continuing structural reforms, including of the employment insurance system, tax cuts, and trade liberalization.

Strong at home, weaker abroad

Domestic demand has been the backbone of Canada’s expansion, while net exports have contributed little.

Note: Shaded area indicates projections.

Data: Statistics Canada and IMF staff calculations.

Looking ahead

The economic outlook remains broadly favorable, but external developments are creating significant uncertainties. A series of shocks hit the economy in 2002—03, including an almost 30 percent exchange rate appreciation vis-à-vis the U.S. dollar, an outbreak of Severe Acute Respiratory Syndrome (SARS), forest fires, a large power outage, and a case of “mad cow” disease. Nevertheless, the economy rebounded strongly in 2004 and is expected to continue expanding in 2005, supported by a pickup in investment, rising personal incomes, and buoyant corporate profits. “Canada’s strong macroeconomic framework and flexible economy have positioned the country well to respond to macroeconomic disturbances,” said Tamim Bayoumi, Assistant Director and mission leader to Canada in the IMF’s Western Hemisphere Department.

Leading the packDuring 1995-2003, Canada recorded the fastest growth and the strongest budget position among the major industrial countries.
General government

(percent of GDP)
Real GDPGDP per

capita

20031
Net debt
Per capitaFiscal BalanceChange
GrowthgrowthAverage20031995-20032003
Canada3.52.531,9420.01.2-34.534.8
France2.21.827,047-3.0-4.13.842.7
Germany1.21.128,104-2.5-3.912.352.0
Italy1.51.527,480-3.4-2.5-11.693.6
Japan1.21.028,278-6.2-8.054.979.4
United Kingdom2.82.427,777-1.2-3.2-3.833.5
United States3.32.138,031-1.3-4.7-12.746.2
Unweighted average
excluding Canada2.01.629,453-2.9-4.47.257.9

In U.S. dollars at purchasing power parity exchange rates.

Data: IMF, World Economic Outlook; and OECD, Economic Outlook.

In U.S. dollars at purchasing power parity exchange rates.

Data: IMF, World Economic Outlook; and OECD, Economic Outlook.

As an open economy whose exports are concentrated on the U.S. market and contain a high proportion of commodities, Canada remains susceptible to external shocks. Hence, the recent further appreciation of the Canadian dollar, uncertainty about the underlying strength of net exports, and commodity price volatility pose some risks.

In addition, Canada—like other industrial countries—faces a sharp increase in the share of the elderly population. But, Bayoumi said, “owing to its strong macro-economic framework and flexible economy, Canada is already well-placed to face these challenges.” Meeting these challenges would require sustained fiscal prudence, fundamental reform to control health care costs, and structural policies to maximize productivity. Bayoumi added that “additional reform efforts could be directed at reducing the relatively high tax burden, increasing labor utilization, and eliminating the remaining barriers to trade and competition.”

Room to maneuver

As the rebound in growth reduced economic slack in the third quarter of 2004, the Bank of Canada began to withdraw monetary stimulus in September and October of last year. The Bank has since left interest rates unchanged, partly due to concerns over a renewed appreciation of the Canadian dollar in recent months.

“The Bank of Canada has had considerable success in keeping inflation within its target range, which has contributed to very low inflation expectations,” Bayoumi said. Considering the absence of wage pressures, the risks to the outlook, and well-anchored inflation expectations, there was still room for a cautious and pragmatic approach to withdrawing stimulus, consistent with the inflation target.

Improved economic conditions have also helped Canada make further progress in reducing its debt-to-GDP ratio. The federal budget surplus in 2003-04 was well above earlier estimates, reflecting buoyant tax revenue from the rebound in economic activity. Provincial government finances deteriorated slightly, but budgets remained close to balance, and the strength of federal finances left the general government with a significant surplus.

“The Canadian government has embarked on a comprehensive expenditure review, which is likely to generate considerable savings,” Bayoumi said. “At the same time, fiscal room for maneuver is limited by recent commitments to increase federal transfers to provinces.”

The objective of lowering the federal debt-to-GDP ratio to 25 percent within 10 years will be an important element in preparing Canada for the long-term fiscal challenge posed by population aging. In particular, growing health-care spending will increase pressure on the country’s fiscal balances. The IMF stressed that more needed to be done to ensure the sustainability and efficiency of the health-care system through measures that improve incentives for both health-care providers and health-care consumers. “Canada is one of the few countries with a fully funded public pension system,” Bayoumi said. “Therefore, public policy can and should focus on reforming the universal public health system, whose costs have sharply increased in recent years.”

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