Inflation in Canada: The policymaker’s dilemma

lnflation in Canada: the policymaker's dilen1ma DOUGLAS A. L. AULD I The establishment by the Federal Government of a Prices and Incomes Commission heralds a new era of government involvement in the economic life of Canada. This is not, however, the first time that Canadian government has taken this kind of action as a consequence of fluctuating costs and prices in the economy. In 1919, a Special Commission of the House of Commons was appointed following a rapid post-war rise in living costs. The deflation of the 1930's initiated a Royal Commission on Price Spreads. Following World War II a Royal Commission on Prices was appointed in 1945. The present Prices and Incomes Commission , appointed early in 1969, was preceded by a Federal Government White Paper on Policies for Price Stability. The following is an examination of this important Government document, some comments on the problems facing the Prices and Incomes Commission and a brief appraisal of its role until March of 1970. II The purpose of the White Paper was to .... examine the problem of rising costs and prices ... , outline some of the possible causes of this upward price pressure; the range of policies that can be used to combat it; and to propose a combination of policies that should improve our ability to ... [maintain] acceptable cost and price behaviour.1 In the opening paragraph, the paper states, quite boldly, that given present economic policy, it appears that high employment and price stability cannot be achieved simultaneously . This, then, is the dilemma facing the government; both objectives are desiraYear 1965 1966 1967 1968 Source 48 Percentage Increase in Money Supply + 11.9 6.7 14.0 13.7 TABLE Bank of Canada, Statistical Summary National Accounts, Annual. ble but the tools to achieve them at the same time are lacking. This particular problem was, of course; recognized more than 10 years ago by A. W. Phillips at the London School of Economics. Phillips was able to show that there was indeed a statistical "trade-off" between wage increases and lower unemployment. Since there is a close correlation between wage and price movements , the Phillips relationship expresses the relationship between inflation and unemployment . Such a "trade-off" becomes more relevant as the economy approaches full potential output and this, of course, was not evident in Canada until 1964-1965. The White Paper goes on to outline how rising prices and costs have a disruptive effect on the economy, especially in those areas where expenditures are financed by bonds and debentures. Inflation means inflation of interest rates as well as the price of goods and services, and this places a considerable burden on several areas of public expenditure as well as the housing market. For persons on fixed incomes such as pensions and annuities or those with little bargaining power in the economy, the problem of inflation poses a considerable hardship. An annual pension granted in 1961 will today purchase less than three-quarters of the goods and services it commanded in 1961. Turning to the early stages of this present inflationary period, the White Paper makes the following statement: 1 When it became apparent in the course of 1965 that demand was beginning to put the pressure on the supply capacity of the economy, monetary and fiscal mechanisms were applied to restrain the growth in demand. These conventional economic policy instruments not only succeeded in slowing demand, they did so without throwing the economy into a recession.2 Let us look at the facts. Federal Government Expenditure $ 7.9B 8.4 9.6 10.9 Percentage Change + 5.3 + 6.3 +14.3 +13.6 and D.B.S. Revue d'etudes canadiennes The above stat1st1cs seem to indicate that although there was a reduction in the rate of increase in the money supply in 1966, over the four year inflationary period 196568 , the average annual rate of increase in the money supply was more than 11 % . This, of course, was considerably more than the average annual rate of increase in real gross national product. Furthermore, if we look at expenditure by the federal government , we find a steady increase over the four years with substantial changes...