The Supply of Money and Government Intervention
The supply of money in the economy can either steer growth or lead to inflation. Therefore, governments tend to regulate the circulation of the currency to stabilize the economy. Monetary and fiscal policies are powerful tools that are very powerful tools. However, other instruments must also be employed. In the first section of the text, a brief introduction of the history of economic trends Canada in the history of Canada is outlined to show the changes in GDP, investment, unemployment, and savings and forecast the trend in the next five years. Additionally, the text explores how government policies of fiscal and monetary policies influence price levels, costs, rates of inflation, real and other nominal variables. In addition, the paper analyzes the influence of trade surplus and deficit on the productivity and growth of the economy. Similarly, the text discusses the relevance of markets for loanable funds and foreign-currency exchange in achieving a government's strategic plan. The text focuses on interest rates and value of the currency to explain the impact of these government instruments and policies. This paper tends to create an understanding of the importance of regulating the circulation of money and the various government policies effects on the productivity and ultimately the growth of the economy.
Macroeconomic Policies in Canada
Canada's GDP experienced a 2.30 per cent increase in the first quarter of 2018 over the same quarter in 2017. The Annual Growth Rate of the GDP in Canada has averaged 3.17 per cent since 1962, reaching the highest percentage of 9.30 in the first quarter of 1962 and recording its lowest percentage of -4.10 in the last quarter of 1982. However, economists forecast the annual growth rate of GDP to be 2.30 per cent by the end of the 2018 quarter. In the long-term, analyst predicts that the GDP Annual Growth Rate will average 1.50 per cent. From 1990 until 2018, the Interest Rate in Canada has averaged 5.90 per cent, reaching the highest rate of 16 per cent in 1991 and recording the lowest rate of 0.25 per cent in 2009. In the next 12 months, the rate is anticipated to hit 1.5 per cent. However, in the long run, analysts predict the rate trend around 2.25 per cent. The rate of youth unemployment in Canada has averaged 14.04 per cent from 1976. In 1982, the country had the highest rate at 20.70 per cent and September of 2017 witnessed the lowest levels of unemployment at 10.30 per cent. However, analysts project the rate average 11.80 per cent in the next five years ("Trading Economics", 2018).
Government Macroeconomic Policies
Since business experience economic booms and busts are part of the business cycle, which are patterns of contractions and expansions in an economy, Governments often intervene using fiscal and monetary policies in an attempt to maintain economic stability. In an open economy such as Canada's, millions of individual consumers and firms interact on a daily basis to determine the production, demand, price, and supply of various goods and services. Nonetheless, the government always plays a vital role in such economies even when they are predominantly market economies, such as the United States and Canada. The government raises revenue through taxation and spends these resources by providing social amenities such as health care, education, defense, and public housing. Beside taxation and direct expenditure, the governments influence on the economy can be exercised through other instruments such as regulations imposed in certain areas including foreign ownership, product safety, licensing, quotas for production, and minimum wages. Macroeconomic policy is divided into two broad types: fiscal policy and monetary policy (Benigno "Woodford, 2003).
Fiscal Policy
The fiscal policy encompasses the set of decisions made by the government at any level, i.e. federal, provincial, or municipal, with respect to spending, taxation, and borrowing. In Canada, all levels of governments have their own fiscal policy, since they are all capable of raising revenues through taxation and can spend these funds on services and goods (Zagler, " Dürnecker, 2003).
If a government desires to stimulate growth in the economy, its spending on goods and services will increase. In turn, demand for goods and services will increase. The increase in demand goes will consequently cause a rising increase in production. Subsequently, companies will feel the need to increase the labor required to meet the rising demand thus creating jobs in the economy. People that were once unemployed may now have a source of income and extra money to spend on services and goods thus further increasing the demand, and in turn, require more production and the cycle of growth continues (Zagler, " Dürnecker, 2003).
On the other hand, the economy may be growing too fast and the government may want to slow it down. In this case, the government reduces its expenditures. A reduction in government spending has the effect of decreasing the overall demand in the economy. In effect, companies reduce the production process, which means a decline in profits and subsequently fewer employment opportunities and business investments. When the government reduces its spending, the public has little money to spend or save. Financial institutions increase the interest rates to discourage unnecessary borrowing (Zagler, " Dürnecker, 2003).
Taxation is another fiscal instrument used by the government to intervene and maintain economic stability. Decreasing taxes stimulates economic growth since the citizens will have extra money to spend or save. When this extra money is spent, the demand increases and thus companies produce more. In turn, employment opportunities are created giving more people more money creating a new wave of demand and the cycle continues. On the other hand, if the money is saved in the money. The bank loans it to borrowers who in turn spend it to slow down an overheating economy, the government may raise the taxes. The result of tax increase is a reduction of money that people can spend. This translates to fewer investments and employment opportunities hence less demand. In turn, the economy will slow down (Zagler, " Dürnecker, 2003).
Monetary Policy
Monetary policy refers to the regulation of the amount of money in circulation in an economy. Normally, monetary policies are exercised by the governments through its central bank. The Bank of Canada uses monetary policy by adjusting the short-term interest rates to attain a certain rate of monetary expansion that will ensure that the country's inflation rate remains low and relatively stable (Gali " Monacelli, 2005). There are three main characteristics of monetary policies in Canada:
1. The Bank of Canada, which is a government-owned Crown corporation, conducts the monetary policy. The Bank nonetheless, operates with a certain degree of independence from the federal government. However, it is accountable to parliament.
2. In the same manner that financial capital moves easily within Canada, interest rates on similar assets are the same across the country. In effect, only one monetary policy is necessary for the whole of Canada. Furthermore, the Bank of Canada is the sole issuer of bank notes in Canada.
3. The Bank of Canada only has one policy instrument even though there are numerous economic variables that influence monetary policy decisions
Monetary policies are limited compared to fiscal policies as they can only achieve one thing, i.e. regulate the supply of money in the economy. This is because the Bank of Canada does not have the ability to make expenditure or taxation policies at any government levels. Neither can it have the ability to regulate the labor markets or product market directly. However, it plays a limited role in the oversight and regulation of some segments of the financial system. Nonetheless, it is a powerful instrument in determining growth and productivity (Gali " Monacelli, 2005).
How Monetary Policies Work and Its Long Run Impact to the Economy
The government through the Central Bank can affect the demand in the economy by regulating the amount of money circulating in the economy. The quantity of money circulating in an economy is crucial as it affects both macro and microeconomic trends. At the level of microeconomics, an increase in relaxed money supply means more disposable income for personal spending. Furthermore, Individuals can easily get timely car loans, personal loans, or home mortgages. At the level of macroeconomics, the circulation of money in an economy affects the gross domestic product, interest rates, unemployment rates, and overall growth of the economy. Therefore, monetary policies are powerful and effective tools in achieving the desired economic objectives (Balassa, 2013).
There are five strategies for manipulating money suppliers in the economy. First, the central bank may print more money. However, this is the least effective way hence is normally considered last. Secondly, the central bank sets the reserve requirement to either limit or enhance the amount of money the commercial banks can loan. The third strategy is directly influencing the interest rates for loans. Fourth, through the sale of government securities, the central bank affects the quantity of money in circulation in the economy. Lastly, during tough economic times, central banks institute a program of quantitative easing whereby it creates money and uses it to purchase securities and assets such as government bonds. In turn, the money is introduced into the banking system as payment for the assets purchased by the central bank (Balassa, 2013).
However, it may be a while before the impacts of the monetary policies are felt across the economy. Therefore, there is always the probability that the central bank may risk going overboard by either raising or lowering interest rates more than warranted and end up aggravating its imbalance. Nonetheless, in the end, monetary policies control the inflation rates and other nominal variables such as exchange rates. In addition, monetary policies also influence import and exports in an economy (Balassa, 2013).
Influence of Trade Deficits and Surpluses to Growth of Productivity and GDP
Trade deficits occur when a country imports more products than it exports. For instance, if Canada were to import goods worth CAD 600 billion and export goods only worth CAD 200 billion, it would incur a CAD 400 billion trade deficit. In contrast, trade surpluses occur when the exports of a country exceed its imports. As of March 2018, Canada's trade deficit had reached a CAD 4.1 billion, which is an upward trend since the beginning of the year (Mankiw, 2014).
Trade deficits affect quite a number of economic indicators in a country such as the value of its currency, the rate of employment, direct foreign investments, and interest rates among others. These economic indicators can be used to explain the influence of trade surplus and deficit to an economy's productivity and overall GDP (Mankiw, 2014).
Employment
There are negative consequences that affect the economic stability and growth of an economy, which experiences persistent trade deficit. For instance, when the demand for exports exceeds that of the nation's imports, the domestic labor force will lose its market. Although this may make sense theoretically, data suggest that unemployment levels can remain low levels even when a country is experiencing a trade deficit. Likewise, high unemployment may exist in states with trade surpluses. Therefore, economists urge that in interpreting the effect of trade surplus or deficit, the context of the country has to be considered (Mankiw, 2014).
Currency Value
The value of a country's currency is greatly affected by the demand for its exports. Canadian companies exporting their products abroad have to convert those foreign currencies back into Canadian dollars to pay their suppliers and workers, bidding up the value of the Canadian currency. As the demand for exports falls relative to imports, the value of the Canadian currency also declines. Economists agree that theoretically in a floating exchange rate system, a trade deficit is corrected automatically through the adjustments of the exchange rate in the foreign exchange markets (Mankiw, 2014).
Interest Rates
Similarly, persistent trade deficit often has a negative influence on a country's interest rates. The downward pressure on the currency devalues it, making the prices of merchandise measured in that currency more expensive and possible leads to inflation. Inflation leads to monetary policies that encourage high-interest rates. In effect, such policies dampen the economic growth (Mankiw, 2014).
Foreign Direct Investment
Theoretically, the balance of payments always nets out to zero. Therefore, a trade deficit should be offset by a surplus in the financial and capital accounts of the country. Consequently, nations that operate a trade deficit experience an influx of direct foreign investment and ownership of federal debt. However, for developing countries, this is detrimental since a bigger proportion of the nation's resources and assets, which are owned by foreigners who control and influence how them and ultimately determine the productivity and GDP of the country (Mankiw, 2014).
Importance of Market for Loanable Funds and Foreign-Currency Exchange
In an open market-oriented economy like Canada, the two markets—the market for loanable funds and the market for foreign-currency exchange are crucial when interpreting the macroeconomic policies. According to Bade and Parkin (2007), the loanable funds' market has adjustable interest rates to facilitate the balance of funds to be supplied through the loans from the national reserve, as well as their domestic investment and net capital's demand. They argue that for the market for foreign-currency exchange, both the supply and demand of the dollars, i.e. net capital outflow and net exports' balance adjusts with respect to the rate of exchange rate that is real. Net capital outflow is both parts of the loanable funds demand as well as the supply of dollars for foreign-currency exchange. Therefore, the variable that links the two markets in an economy is net capital outflow.
These two markets can be used to explain the impact of government policies budgeting policies that are crucial in achieving its strategic plan. For instance, the Canadian government can adopt policies that reduce its national saving such as operating a budget deficit. In effect, the economy will reduce the supply of loanable funds and in turn, drive up the rate of interest. Consequently, net capital outflow will reduce and so is the supply of the CAD in the market for foreign-currency exchange. Ultimately, the CAD will appreciate while the net exports fall (Bade " Parkin, 2007).
In addition, lender nations participate in the markets for loanable funds and foreign-currency exchange to gain interests from the loans that are in turn, invested further to boost the economic growth of the country. Once the economy of the country improves, companies in the state will also be able to attain strategic plans. The foreign exchange market also enables a country to clear its debts and reduce its foreign currency risks (Bade " Parkin, 2007).
Recommendation
Governments can utilize measures such as the use of tariffs, foreign capital, taxes, legislature, and volume to achieve their strategic plans. Furthermore, for exports investment of a country to increase, the government has to make its currency attractive for foreign investors to purchase them. The above-mentioned measures are elemental in helping domestic companies venture into a foreign market, expanding locally, and ultimately help improve the value of the currency and maintain a trade balance (McCombie " Thirlwall, 2016).
However, while governments may sometimes find restrictive trade policies, such as tariffs and import quotas, useful in altering the trade balance, these strategies do not necessarily have that desired effect. A trade restriction for a given exchange rate will increase the net exports; therefore, increasing the demand for the currency in the foreign-currency exchange market. However, as the value of currency appreciates it makes domestic goods more expensive relative to foreign products. In turn, this appreciation offsets the previous effect of the net exports trade restriction (Yanikkaya, 2003). To achieve a strategic plan, it is critical, therefore, to study the current state of the economy and to forecast the economic state in the years that the strategic plan is to be attained ("Trading Economics", 2018). In addition, considerations must be made for events outside the economy that cause a change in interest rates since these have a significant impact on the economy.
Conclusion
The supply of money in the economy is critical in determining the economic growth of a country. The circulation of money, if not well regulated, could result in hyperinflation with dire consequences for the domestic companies as well as citizens. Therefore, governments through the central banks use fiscal and monetary policies to regulate the amount of money in circulation in the economy at a particular time (Deleplace " Nell, 2016). However, economists warn that caution must be exercised when employing those strategies. For instance, some economists argue that a reduction in taxes and government spending can create a crowding-out effect. Governments sometimes borrow money from the domestic market to support its spending. Government borrowing tends to increase interest rates and consequently discourage individuals and businesses from borrowing money for investment or spending, thus creating a crowd-out effect on private investment (Ganelli, 2003).
International trade is one way that governments can use to influence its growth and productivity. Economic indicators such as employment, interest rates, and the value of the currency are likely to show a positive trend when a country is operating a trade surplus. However, trade surplus or deficit must be translated in the context of the economy to determine the true effect on the economy, as those indicators may still show positive trends when the economy is operating on a trade deficit and negative trend when operating on a trade surplus (Mankiw, 2014).
Lastly, in an open economy like Canada, the market for loanable funds and the market for foreign-currency exchange are also crucial in maintaining trade balance. These markets, in addition to government policies, are instrumental in appreciating the value of the currency, as well as obtaining funds that will steer economic growth (Bade " Parkin, 2007).
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