Overview of macroeconomic and monetary development of Canada
The economy of Canada that relies heavily on export was hit by a decline in oil price and other raw materials achieved a growth rate of 3% in 2017. With this growth rate, Canada has become one of the fastest growing nation in G7 (Benigno, Converse and Fornaro 2015). Growth has increased sharply from 1.41 percent in 2016 to 3% in 2017. Household spending is the biggest contributor of economic growth. Export has also grown along with a growth in business and inventory investment. The natural resource industry expanded by 7.8%. As against this, service industry grew by 2.8%. The federal budget forecasts a growth rate of 2.2% in 2018 and 1.6% in 20019.
Rate of inflation in 2012 was 1.55 percent. In the next year, inflation fell to 0.9 percent. Price level recovered with rate of inflation reaching to 1.9 percent. From 2015 onwards, inflation rate started to fall with rate of inflation being 1.13%, 1.45% and 1.6% in 2015, 2016 and 2017 respectively. Annual inflation rate of Canada in April 2018, inflation rose to 2.2 percent. This was the highest inflation rate since 2014. Prices increased for transportation because of an increase in gasoline price. Because of a decline in cost of travel service, cost of recreation, reading and education fell. Inflation rose slightly for food and household operation (tradingeconomics.com 2018). Price level remained steady for shelter.
As shown in figure 3, unemployment rate in Canada constituted a declining trend in the last few years. Unemployment rate in 2012 was 7.29%, which declined to 7.08 percent in 2013. For the two consecutive years 2014 and 2015, unemployment rate remained at 6.91 percent. Unemployment rate slightly rose to 6.99 percent in 2016 and again fell to 6.34 percent in 2017. Unemployment in May 2018 was 5.8 percent full filling the market expectation. With this, the jobless rate in Canada reached to its lowest level. In the labor market decline in full time jobs only partially offset by a rise in part-time jobs (tradingeconomics.com 2018). Manufacturing, construction, health care and social assistance are the some sectors that record a job loss.
Total debt in Canada shows an overtime-increasing trend. Total debt in Canada during 2012 was 1191. 37 US dollar. Debt rose to 1254.08 in 2013. Total debt continued to increase with debt reaching to 1481.65 US dollar in 2017.
In 2012, the recorded interest rate in Canada was 2.33 percent. In 2013, interest rate rose to 2.72 percent. The rise in interest rate causes a decline investment. After that, interest rate continued to fall until 2016 with interest rate reached to 1.80 percent in 2016 (tradingeconomics.com 2018). In 2017, interest rate rose to 2.20 percent.
The figure above measures exchange rate for Canadian dollar as against US dollar. There is an upward rising trend in the exchange rate. Exchange rate in 2012 was 1.00, which rose to 1.33 in 2016. The rise in exchange rate implies a depreciation of Canadian dollar. Exchange rate slightly declined to 1.30 in 2017 indicating an appreciation of CAD.
Monetary policy of Canada
Designing appropriate monetary policy is one of the core function of Bank of Canada. The primary objective of monetary policy in Canada is to keep inflation at a low, stable and predictable level. This helps Canadian to gain confidence in making investment and spending. This in turn secures a stable long-term investment for the economy contributing to creation of new job opportunities and enhances a higher productivity. This leads to a higher standard of living of Canadians (Correa et al. 2017). The framework of monetary policy in Canada comprises of two key constituents- target of inflation control and flexible exchange rate.
Target of inflation control
Controlling inflation is the heart of monetary policy framework of Canada. The targeted inflation rate is 2 percent, which is the midpoint between 1 and 3 percent. Federal government and Bank of Canada determine the target jointly. The target is reviewed in every five years. The targeted inflation rate guides decision of the Bank in setting the interest rate (bankofcanada.ca 2018). The interest rate is set in such a way that a stability in the price level can be maintained in the medium-term.
Bank of Canada adjusts the overnight rate to attain its targeted inflation rate. The overnight rate is the rate that the Bank uses to offer loans to financial institution. This is the key rate that other banks and financial institutions use to determine interest rate charged on consumer loans, mortgage and other lending (Tang and Wang 2015). When inflation is more than the targeted level then Bank increases the policy rate. If actual inflation rate is lower than the targeted rate then the Bank lowers policy rate.
Flexible exchange rate of Canada
The floating exchange rate of Canadian dollar allows Central Bank to design an independent monetary policy suitable for economic state of the nation and accomplishes inflation target (bankofcanada.ca 2018). The free movement of exchange rate helps to economy to adjust to internal and external shocks
Regression Analysis
A regression analysis is conducted to evaluate real money demand function taking real GDP and month T-bill rate as the determinants of the real money demand. The following model to set to frame real money demand.
M/P: real money demand
Y: Real GDP
r: Nominal interest rate
w: Constant
Output of the regression model is given below
Based on the regression result, real money demand function is estimated as
The regression result gives R square value as 0.99. High value of R square indicates a strong relation between real money demand and inflation and real GDP. This implies inflation and real GDP can together account for 99 percent variation in real money demand. High R square value indicates the model is a good fitted model and hence, is highly satisfactory (Draper and Smith 2014).
The co-efficient of T-bill rate is positive having a value of 0.000012. From the model, the positive coefficient for nominal rate indicates interest rate has a negative influence on money demand. This is rational as higher interest rate means a higher opportunity cost of holding money. Hence, a higher interest rate means a lower money demand. Now, given fixed supply of money M2, smaller money demand means a higher price level or inflation (Goodwin et al. 2015). Therefore, the co-efficient actually depicts an inverse relation between interest rate and inflation rate. Associated p value for the coefficient is 0.9419. The p value greater than value of 5% level of significance indicates that the concerned variable is statistically insignificant.
The co-efficient of real GDP is 0.000018. The positive coefficient indicates a positive impact of real GDP on real money demand. As real GDP increases, real money demand increases and vice-versa. An increase in real GDP indicates implies a higher average income (Bernanke, Antonovics and Frank 2015). This in turn increases demand for money. P value for the co-efficient is obtained as 0.0001. P value less than significance level of 0.05 implies the variable is statistically significant. Real GDP thus is a positive determinant of real money demand.
From the regression result, real GDP and Month T-bill rate found to have only negligible impact on real money demand and inflation. These two however have important effect on monetary policy conduct. The Treasury bill rate turn out to be statistically insignificant. In reality, treasury bills are important instrument of Canadian money market. In order to influence money supply indirectly central bank alters Treasury bill rate through open market operations (Bailliu, Meh and Zhang 2015). Bank of Canada also revises growth target along with targeted inflation rate.
Conclusion and Recommendation
The paper summarizes recent macroeconomic and monetary development of Canada. Following a decline in global oil price Canada experienced a slow growth rate the two consecutive years of 2015 and 2016. Growth however is recovered in 2017 with the recorded growth rate being 3%. Inflation has remained within the targeted level with a decline in unemployment rate. Bank of Canada conducts the monetary policy of Canada. The main objective of monetary policy is to attain a low and sustainable inflation rate. For this, Bank of Canada uses overnight interest rate along with other short run interest rate. Real GDP found to have a significant positive influence on real money demand. Increases in money demand can lead to demand side inflation pushing inflation beyond the targeted level. Then Bank of Canada should use nominal interest rate to keep the money demand in control along with achieving the targeted inflation rate.
Canada is a highly developed nation having structure of a mixed economy. In terms of nominal GDP, it ranks 10th in world. Like most of the developed nations, the economy of Canada is highly dependent on its service sector. Service sector employs 75 percent of laborers in Canada. Canada has a huge stock of natural resources. Natural resources in Canada valued approximately US $ 33.2 trillion in 2016. Because of abundant natural resources, the Canada is also considered as an ‘energy superpower’ (Arnold et al. 2018). The paper first discusses macroeconomic performance of Canada with attention given on real GDP growth rate, inflation rate, unemployment rate, total debt, interest and exchange rate. Bank of Canada designs monetary policy of Canada. In this context, instrument and target of monetary policy is discussed in reference to real money demand function.
Reference:
Arnold, C.H., Wheelahan, L., Moodie, G., Beaulieu, J. and Taylor-Cline, J.C., 2018. Mapping the typology of transition systems in a liberal market economy: the case of Canada. Journal of Education and Work, 31(2), pp.125-143.
Bailliu, J., Meh, C. and Zhang, Y., 2015. Macroprudential rules and monetary policy when financial frictions matter. Economic Modelling, 50, pp.148-161.
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Bernanke, B., Antonovics, K. and Frank, R., 2015. Principles of macroeconomics. McGraw-Hill Higher Education.
Correa, R., Paligorova, T., Sapriza, H. and Zlate, A., 2017. Cross-Border Bank Flows and Monetary Policy: Implications for Canada. Bank of Canada.
Draper, N.R. and Smith, H., 2014. Applied regression analysis(Vol. 326). John Wiley & Sons.
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Data Source:
Data.worldbank.org. (2018). Official exchange rate (LCU per US$, period average) | Data. [online] Available at: https://data.worldbank.org/indicator/PA.NUS.FCRF?locations=CA [Accessed 14 Jun. 2018].
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