Revised - June 18 2003

Structural Adjustment in Canada
Most Canadians would be surprised to learn that economists from the International Monetary Fund (IMF) annually visit Canada to dispense advice. We tend to think of the IMF as an institution that prescribes strong medicine, known as Structural Adjustment Programs (SAPs), only to less developed countries. In fact our governments regularly follow the same bitter prescriptions.
 
In 1990 Prime Minister Brian Mulroney boldly declared that Canada needed to undergo structural adjustment which he promised to deliver through free trade agreements with the US and Mexico and harsh spending cuts. Little changed when the Liberals came to power. Much of the content of Finance Minister Paul Martin’s crucial 1995 budget that slashed our social safety net followed directives that came straight from the IMF.
 
Where did SAPs come from?
Structural Adjustment Programs are a product of the debt crisis of the 1980’s. SAPs are designed to reorient a country’s economy towards earning as much foreign exchange as possible in order to make payments on its overseas debts. When the IMF’s standard austerity measures failed to resolve the debt crisis, US Treasury Secretary James Baker took the initiative to implement a new strategy involving more far reaching changes.

The “Baker Plan” was introduced at the 1985 annual meetings of the IMF and the World Bank. Baker recruited the World Bank for the task of imposing a whole new set of “structural” conditions on top of the austerity measures that are usually prescribed by the IMF. By the middle of 1989 the World Bank had extended structural adjustment loans to three quarters of the countries that already had stabilization loans from the IMF. Soon the IMF expanded its own lending programs to include Structural Adjustment Facilities imposing similar broad conditions.
 
Classic IMF stabilization programs involve a standard set of policies aimed at reducing current account deficits. These invariably include a contraction of the money supply and fiscal austerity measures aimed at reducing “excessive demand” in the domestic economy. SAPs incorporate these macroeconomic policies and extend conditionality deeper and deeper into areas of national policy.
 
SAPs typically include demands for strict anti-inflationary monetary policy, privatization of public enterprises, trade liberalization and dismantling of foreign exchange controls. Recently the list of policy changes has emphasized demands for more flexible labour markets.
 
SAPs typically aim at reducing the size of the public sector. This has meant the elimination of subsidies and marketing boards for agricultural products. The result has been higher input prices for farmers with the result that only the larger farms can survive.
 
These agricultural policies have eacerbated the highly skewed land distribution patterns in most developing countries. SAPs have ignored land reform, the most basic structural issue in agriculture. In some cases such as Peru, Chile and Ethiopia land reform has been reversed under SAPs. (Dasgupta 1998:115)
 
Recently SAPs have involved the privatization of such basic services as potable water and sanitation. Mozambique’s SAP required the privatization ofsome rural water and sanitation services in order to qualify for loans from the IMF. SAPs have also begun to intrude into the design of social programs, often by requiring governments to institute user fees for health care or education. In Tanzania, 3 public hospitals saw attendance drop by 53% when user fees were introduced. In Nicaragua about a quarter of primary school children did not enroll in school after charges for registration and a monthly stipend were introdced.
 
The extent of SAPs intrusion into the sovereign affairs of nation states is summed up by Jonathan Cahn (1993:160) writing in the Harvard Human Rights Journal:
 
“The World Bank must be regarded as a governance institution, exercising power through its financial leverage to legislate entire legal regimens and even to alter the constitutional structure of borrowing nations. Bank-approved consultants often rewrite a country’s trade policy, fiscal policies, civil service requirements, labour laws, health care arrangements, environmental regulations, energy policy, resettlement requirements, procurement rules, and budgetary policy. The Bank plays this legislative role primarily by imposing conditions on its loans.”
 
Liberation of the Private Sector
SAPs impose a strict neo-liberal economic and social agenda designed to reduce the role of government and increase the power of private corporations. From the beginning transnational corporations applauded SAPs. One of the largest US banks, Morgan Guarantee Trust, welcomed the Baker Plan because SAPs promised the “liberation of the private sector from distorting price, wage, trade, exchange and credit controls.” (Cited in ECEJ 1990:8)
 
Mexico illustrates how thoroughly SAPs can literally turn a country inside out. Mexico was one of the first countries to undergo thorough structural adjustment. For decades, Mexico had pursued a model of import substitution industrialization that encouraged domestic firms to produce for the home market. Under pressure form its creditors, Mexico joined the General Agreement on Tariffs and Trade (the prdecessor of the World Trade organization) in 1985 [CHECK]. Mexico unilaterally tore down trade barriers and embarked on a pattern of export oriented development dependent on foreign investment.
 
Transnational corporate investors were very pleased with the opportunities this new strategy presented to them. Between 1989 and 1994 investors in Mexico and other “emerging markets” earned average annual returns of 19%, almost twice as much as the 10.5% they could earn by investing in stocks listed on the Standard and Poor’s Index. (Dillon 1997:72) While SAPs made Mexico lucrative for foreign investors, they still had to face the possibility that some future Mexican government might reverse course and return to more inward looking development strategy.
 
The North American Free Trade Agreement (NAFTA) proved to be  ideal instrument for preventing mexico from abandoning the export oriented model. NAFTA is designed to make permanent the neoliberal structural adjustment policies of the Salinas government. The US Ambassador to Mexico, John Negroponte, made NAFTA’s true mission clear in a 1991 memo he wrote to the US State Department which was leaked to newsmagazine Proceso (No.758 13/05/91:7): “[NAFTA] can be seen as an instrument to promote, consolidate and guarantee continued policies of economic reform in Mexico beyond the Salinas administration.”
 
Mexican workers bore the brundt of the industrial restructuring that occured under NAFTA. While foreign investment created some low-wage jobs in the maquiladora export-processing plants, 77,839 jobs were lost from the higher-paying traditional manufacturing sector during the first two years of NAFTA alone. Some 400,000 more jobs were lost when the Salinas government privatized some 269 public enterprises. Foreign investors mostly purchased existing national firms rather than making new “greenfield” investments.
 
Do SAPs Achieve Their Goals?
Have SAPs succeeded in meeting their goals? The answer to this question usually depends on the bias of the analyst. Fund and Bank economists defend their programs on the gounds that structural adjustment is needed in order to set the stage for growth. “Short-term pain for long-term gain” is their mantra.
 
But has this really worked? The Meltzer Commission (2000) report prepared for the US Congress cites the following summary of several studies of IMF SAPs: “It is now well-accepted that Fund-supported programs improve the current account balance and the overall balance of payments. The results for inflation are less clear... In the case of growth, the consensus seems to be that output will be depressed in the short-run as the demand reducing elements of the policy package dominate.”
 
The IMF’s insistence on tight monetary policies and fiscal austerity inhibits rather than stimulates growth. These policies lead to continued recession and more debt. A study by The Development GAP (1999:1) found that the longer countries remain under structural adjustment the worse their debt burdens become. The study shows that “there is a positive linear relationship between the number of years that countries implement adjustment programs and increases in debt levels... [SAPs are] likely to push countries into a tragic circle of debt, adjustment, a weakened domestic economy, heightened vulnerability, and greater debt.”
 
Yet World Bank and IMF economists continue to apply the same “Washington consensus” formula of neo-liberal policies not because they have worked in the past but because their textbooks say they should work. John Mihevc (1995:28-29) describes how the fundamentalist convictions of the Bank and the Fund’s staff lead them to promote structural adjustment as “the universal path of salvation not only for Africa but for all of the Third World, endowing SAPs with a moral authority and superiority over competing claims, condemning opponents of SAPs as irrational, inefficient or self-serving and finally, fulfilling its anointed role of establishing, controlling and maintaining the SAP agenda.”
 
Like all true-believers, IMF economists display a single-minded commitment to concepts like “getting the prices right” or “keeping inflation contained” to the exclusion of considerations of the human consequences.
 
A Dissenting Voice from Within the System
The mismanagement of the 1997 Asian financial crisis by the IMF led to increased criticisms of its policies by several mainstream economists who had formerly supported structural adjustment. The most prominent of these critics was Joseph Stiglitz, the chief economist at the World Bank.
 
Over the period 1998-99 Stiglitz became increasingly critical of IMF and World Bank policies. Stiglitz opened up a debate by questioning some of the basic tenets of the Washington consensus. In a remarkable speech delivered in Helsinki, Finland, Stiglitz (1998) gave voice to the following challenges:

• trade liberalization and privatization are not ends in themselves;
• moderate inflation (below 40% a year) is not harmful. Single-minded preoccupation with inflation results in macroeconomic policies that stifle growth;
• private financial markets do not do a good job of selecting the most productive recipients of funds;
• budget deficits can be acceptable given the high returns to government investment in such areas as primary education and physical infrastructure;
• macro-economic stability is the wrong target when it downplays the stabilizing of output and employment;
• large-scale unemployment is clearly inefficient - representing idle resources;
• markets are not automatically better than government involvement.

Soon Stiglitz’ criticisms annoyed the US Treasury so much that it engineerd his removal from the World Bank. Since leaving the Bank, Stiglitz has become even more outspoken in his criticisms, questioning how conditionality undermines democracy. At the time of the April, 2000, protests in the streets of Washington against the Bank and the Fund, Stiglitz published an article in The New Republic expressing sympathy for demonstrators’ claims that the IMF “is arrogant; ... does not really listen to the developing countries it is supposed to help; ... is secretive and insulated from democratic accountability ... [Its] ‘remedies’ often make things worse - turning slowdowns into recessions and recessions into depressions.”
 
Stiglitz goes on to describe how the IMF dispatches teams of economists on “missions” to spend a few days or, at most, weeks in a country to develop an economic program:
 
“Needless to say, a little number-crunching rarely provides adequate insights into the development strategy for an entire nation. Even worse, the number crunching isn’t always that good. The mathematical models the IMF uses are frequently flawed or out-of-date. Critics accuse the institution of taking a cookie-cutter approach to economics, and they’re right. ... [In] one unfortunate incident ... team members copied large parts of the text for one country’s report and transferred them wholesale to another. They might have gotten away with it, except the ‘search and replace’ function on the word processor didn’t work properly, leaving the original country’s name in a few places.”
 
Canada Takes the Same Medicine
Canadians may be inclined to think that we are exempt from the prescriptions of the IMF’s economists but this is not the case. We too have been subject to IMF advice willingly implemented by our own governments.
 
The implementation of structural adjustment in Canada began under the Mulroney government. The most important instrument of restructuring was the bilateral Free Trade Agreement with the United States. The FTA led to a substantial reorientation of Canadian industry. Between 1988, the year before the FTA took effect, and 1994 the share of the domestic market served by Canadian manufacturers fell from 58% to 44%. Meanwhile, Canadian industries re-oriented themselves to serve a continental market.

To a very real extent, the Canadian economy has become a regional economy within the North American market. North-South trade has become much more important than East-West commerce within Canada.

Since its election in 1993 the Liberal government has largely pursued the same structural adjustment policies as their Conservative predecessors. In fact they have carried them further by ratifying the North American Free Trade Agreemnt. NAFTA involves more than just adding Mexico to the free trade area. NAFTA includes many provisions that were not in the FTA that necessitate a restructuring of Canadian industires. For example, a whole chapter on intellectual property rights makes it more difficult to pursue made-in-Canada solutions to social needs such as the prvision of cheaper generic medicines.

Moreover, NAFTA extended the scope of prohibitions on the type of performance requirements that governments might demand of foreign investors. For example, the ability of Canadian governments to demand that foreign firms hire Canadians, use local inputs or transfer technology is more restricted under NAFTA than under the investment rules of the World Trade Organization.

The Six Pillars of Canada’s Structural Adjustment Program
reprinted from The CCPA Monitor March 1999 by David Robinson

1. Fiscal auterity: Neo-liberals argue that governments must drastically reduce their spending, particularly spending on social programs. Public programs, they contend, are inherently inefficinet. When public spending is reduced, taxes - especially taxes on corporations and the wealthy - can be cut and money spent to generate wealth in the private marketplace.
2. Monetarism: This policy argues that governments must use high interest rates to fight price inflation. By drastically raising interest rates and slowing economic growth, however, this “tightening” of the money supply translates into a steep rise in unemployment.
3. Privatization and deregulation: Neo-liberal economists argue that government intervention in the economy creates inefficiencies, “crowds out” private investment, and adds to business costs. They advocate privatizing crown corporations and eliminating or weakening regulations, such as labour standards, environmental safeguards, and health and safety protections.
4. Minimal social safety net: Social programs, neo-liberals allege, undermine Canada’s international competitiveness by raising taxes on individuals and businesses. Programs such as UI and social assistance are also said to create “rigidities” in the labour force. That is, benefits are seen to be too generous and to discourage people from taking low-wage jobs. Neo-liberal “reforms” to social programs aredesigned to cut benefits, tighten eligibility, and eliminate universality.
5. Limited economic and social rights: Neo-liberalism also esposes an extreme version of individualism and is openly hostile towards so-called “special interest groups” - unions and progressive social movements which struggle for economic and social rights for disadvantaged groups such as women and ethnic and sexual minorities.
6. “Free” trade and investment liberalization: Trade and investment agreements, like the Canada-U.S. FTA and NAFTA, lock into place neo-liberal policies. These agreements explicitly restrict state intervention in the economy, weaken the powerof trade unions, and force a downward harmonization of labour, environmental and social standards.

“We Need Structural Adjustment in this country”: Mulroney
In October of 1990 Prime Minister Brian Mulroney told a Saint John, New Brunswick, radio audience: “Canada ... [is] going to be thrust into a brutal, uncompromising, challenging trade situation where people... are going to have to fight for jobs. We’re going to need structural adjustment in this country, and that requires a government that’s going to take tough decisions, hard decisions. The Free Trade Agreement is tough... and budgetary cuts are tough, but they’re needed to strengthen... the Canadian economy.” (cited in The Globe and Mail 19/10/90)

Earlier that same year Finance Minister Michael Wilson had echoed Mulroney’s language when he rose in the House of Commons to deliver his budget speech. He spoke about several “structural reforms” needed “to allow our economy and Canadians to adjust to change”. Wilson explained why Canadians had to make adjustments in the following terms: “Let’s be clear about the real source of pressure for change. It is not the government. It is the rapidly evolving and increasingly competitive world in which we must earn our way.”

The principal elements of Canada’s Structural Adjustment Program outlined in Wilson’s speech were:

• Free Trade Agreement with the United States
• deregulation of energy
• "tax reform” lowering taxes for corporations (the regressive GST was introduced in 1989)
• a new labour market strategy to “increase the flexibility of the workforce” allowing for more part-time and contract labour
• privatization of 20 firms, including Air Canada and Petro-Canada
• an anti-inflation monetary policy involving high interest rates
• cuts in federal spending, including reduced transfers to the provinces for social spending.

We do not know to what extent Wilson was literally following IMF advice. The confidential memoranda delivered to Wilson by economists from the IMF have not yet been made public. What we do know is that five years later, Finance minister Paul Martin based his budget on recommendations from a ateam from the IMF.

Every year the Fund sends a team of economists to evaluate the economic performance of each of its members, including “more developed” countries like Canada. These missions are known as “Article IV consultations.”

The actual text of Article IV of the IMF’s Articles of Agreement only refers to a mandate to “exercise firm surveillance over the exchange rate policies” of its members. However, over time Article IV reviews have become far more wide-ranging. The wide scope of these consultations constitutes a prime example of the IMF’s “mission creep,” that is, the expansion of its powers far beyond what was envisaged by its founders. An Article IV consultation is more like a complete physical exam from the doctor than a diagnosis of a particular ailment.

The Halifax Initiative, a national coalition of non-governmental organizations, recently used the Access to Information Act to obtain copies of some Article IV review statements from the Department of Finance. These documents confirm what we had suspected. The IMF’s prescription for Canada is identical to the policies it enjoins indebted less developed countries: anti-inflationary monetary policies; fiscal austerity; more flexible labour markets and privatization of publicly owned enterprises.

Taking the IMF’s Advice
The broad outlines of what was to become the crucial 1995 budget may be found in the December 9, 1994 “Statement by the Fund Mission to the Minister of Finance”. The statement begins with advice “to consolidate the federal fiscal position by ... cutting government spending ... It is critical that fiscal policy take the lead.” (IMF 1994:1)

Following the IMF’s advice Martin slashed spending more than Wilson and other Tory Finance ministers had ever dared. All the Conservatives’ gradual cuts to social programs were no where nearly as significant as the mammoth spending cuts and wholesale overhaul to social programs incorporated into the 1995 federal budget. In his budget speech Finance Minister Paul Martin (1995:6) announced that he intended to “redesign the very role and structure of government itself.”  

Overall Martin announced $29 billion in spending cuts over 3 years. The measures with the greatest impact included:

• the Canada Health and Social Transfer (CHST) which replaced Established Program Financing (EPF) and Canada Assistance Plan (CAP) transfers to the provinces;
• the CHST cut $7.4 billion from transfers to the provinces for health care, post-secondary education and social assistance over 2 years;
• the CHST’s formula for block funding also reduced the federal role in setting social policy;
• 45,000 public sector jobs to be eliminated;
• 19% funding cut for all federal departments;
• proposed child care program cancelled;
• $950 fee levied for immigration applications which became known as “the head tax”;
• 10% minimum cut in Unemployment Insurance program;
• privatizations: Air Navigation System; all airports; Canadian National Railways; remaining 70% public share in Petro-Canada

The 1994 IMF memorandum advised Canada to use “fiscal adjustment measures... to moderate the expansion of aggregate demand...” to make it easier to contain inflation. (IMF 1994:2) In the memo the Fund displayed its ever-present preoccupation with preventing “pressures that would reignite inflation.” (IMF 1994:1) This advice was proffered despite the fact that inflation in Canada, as measured by the Consumer Price Index, had already declined from 5.6% in 1991 to just 0.2% in 1994. At the time some economists were saying that the real threat was deflation, that is falling rather than rising prices. Yet Martin did not make any change to monetary policy. Instead he called on the Bank of Canada to keep Canada “one of the lowest inflation countries in the world.”

The Fund economists appended to their 1994 report a detailed list of measures that could be used to achieve the desired fiscal adjustment. The list is composed almost entirely of suggestions for spending cuts since, in the Fund’s view, the need to remain internationally competitive limits the scope for tax increases.
 
IMF Intrusion Redesigns Social Policy
What is shocking about the IMF’s 1994 statements is not the predictable direction of the Fund’s advice but the specificity of its prescriptions. For example, the 1994 review even contains a recommendation that the government eliminate regional programming and other television services by the Canadian Broadcasting Corporation. The IMF’s pro-free market bias blinds it to the role that the CBC plays in binding together Canadians spread out over vast distances. The cultural importance of enabling Canadians to tell their own stories in the face of the dominance of US media means nothing to the IMF.  

The cuts proposed by the IMF affected not only the amount of social spending but also the nature of our social programs. For example, in the statement of its 1993 mission to Canada the IMF bluntly accused Canada’s Unemployment Insurance system (UI) of reducing “incentives to work” and called for “cuts in the UI benefit rate and regional extended benefits”. (IMF 1993:3)

The accompanying table shows how closely the Liberal government followed the IMF’s structural adjustment advice in the 1994, 1995 and 1996 federal budgets.

IMF Advice
(1994 except for UI in 1993)
Subsequent Canadian Policy

Canada Assistance Plan: “Consideration could be given to placing the CAP on a block basis.”
CAP eliminated and replaced by reduced block transfers to the provinces under the CHST. (1995 budget)

Established Program Financing -  Health: “Cuts in EPF-Health transfers to the provinces could encourage greater efficiencies or cost recovery in the health sector”
EPF for Health replaced by reduced block transfers to the provinces under the CHST. (1995 budget)

EPF - Post Secondary Education (PSE): “Federal transfers for PSE could be reduced in order to encourage a more efficient use of education resources.”
EPF for PSE replaced by reduced block transfers to the provinces under the CHST. (1995 budget)

Elderly benefits: “A major reform would involve replacing the existing OAS (Old Age Security) and GIS (Guaranteed Income Supplement) transfers... in favor [sic] of a means-tested benefit that would be recovered on the basis of family income.”
1996 budget proposed to replace OAS and GIS with a new means-tested Senior’s Benefit.  These plans were abandoned in 1998 under public pressure.

Unemployment Insurance: “Reform of the UI System - including cuts in the UI benefit rate and regional extended benefits...” (IMF 1993 Statement of Mission)
1994 budget raised minimum qualifying period for UI from 10 to 12 weeks; cut regional benefits from 32 to 26 weeks; introduced two-tier benefits - rates drop from 57% to 55% of insurable earnings except for low income claimants; and cut UI premiums.

Housing: “Cuts [to Crown Corporations] could involve... eliminating transfers... to the CMHC.” (Canada Mortgage and Housing Corporation)
1996 budget eliminated federal role in building new social housing after years of budget cuts since 1989.

Other spending: “In many areas there may be a limited need for an extensive federal regulatory or supervisory presence. Such areas include agricultural policy, labor [sic] market policies, natural resource policy, Indian and Inuit affairs, and social policies. There would also seem to be scope for reductions in outlays... [for] fisheries and industry... [and] research. There would seem to be scope for rationalizing these services with a view to increasing the private sector’s responsibility for such activity.
1995 budget included a 19% funding cut for all departments and a plan for eliminating 45,000 public sector jobs.    

Still Not Satisfied
Despite the deep spending cuts in the 1995 budget, the IMF was still not satisfied. A May 18, 1995 post-budget letter to Finance Minister Martin, signed by Managing Director, Michel Camdessus, summarizes an IMF Executive Board discussion. Camdessus (1995) “commends” Martin for his “political courage.” However, he adds that “a more fundamental correction of the fiscal situation was warranted.” He calls for more changes to benefits for the elderly which Martin did attempt when he introduced a Senior’s Benefit in his 1996 budget that later had to be withdrawn.

Camdessus also calls for further reforms to UI, more cuts to transfers to Crown corporations and cultural subsidies. Camdessus calls the CHST “a first step” saying there were opportunities to “achieve further saving.” He also says the “potential for increasing tax revenues may be limited given that the effective tax rates are already high compared to the United States.”

On November 16, 1999 the IMF delivered another annual statement to the Minister of Finance. The IMF (1999) is pleased with the Bank of Canada’s success at keeping inflation low. It qualifies the changes to unemployment insurance (which prevent two thirds of the unemployed from receiving benefits) as “improvements” because they have increased “the flexibility of the labor (sic) market.” Nevertheless, it calls for additional changes to the UI system such as “phasing out the system of regional extended unemployment insurance benefits … to reduce the disincentives to labor (sic) mobility.”

The IMF also approves of the “restructuring of provincial social assistance programs” without any recognition of the human cost of massive cuts to welfare benefits. In a background paper released in March, 1999, the IMF suggests that Canada should limit the time that employable people can stay on welfare. In the US two-year time limits have been imposed on welfare recipients causing extreme hardship, especially for single parents and children left with unsafe childcare. End Legislated Poverty reports that the IMF paper assumes that being on welfare is a “lifestyle choice” and that “social programs should push ... people into the low wage labour market.” (Swanson 2000)

The IMF advises making “debt reduction and income tax reform … the top priorities in allocating the prospective fiscal surplus.” While acknowledging that “some additional moderate spending … [on] education and health care would be useful,” the IMF emphasizes the need to devote more than $3 billion a year to debt reduction and to lower personal and corporate income tax rates which it identifies as high by international standards.

Alternatives
Generally speaking, the IMF’s insistence on tight monetary policies and fiscal austerity has not succeeded in stimulating growth. Rather they have led to continued recession and more debt. In cutting demand too severely IMF programs become self-defeating.

For several years the Canadian Cente for Policy Alternatives and CHO!CES have facilitated a process of writing an annual Alternative Federal Budget. Our AFBs have consistently demonstrated that it is possible to achieve ecologically-sustainable growth without all of the human suffering brought on by monetarism and severe spending cuts.

The key difference between IMF prescriptions and the AFB is that the AFB’s macroeconomic policies are not dictated by a “near-hysterical fear of inflation”. The ideological fixation of IMF economists on fighting inflation at all costs is no where better illustrated than in its December 1994 advice to Canada. It said containing pressures that might reignite price increases had to be a top priority even though inflation had fallen to just 0.2% and Canada was on the verge of a bout of deflation.

Like Joseph Stiglitz, the AFB has always recognized that moderate inflation is not harmful. It may even be helpful, provided that wages and social benefits keep up with rising costs.

In Canada’s case the high interest rates associated with the Bank of Canada’s monetarist assault on inflation, and not government overspending, were the principal causes of the government’s annual deficits. These in turn were the pretexts for savage cuts to public programs.

Almost every year since 1986 the federal government has raised more revenue than it has spent on all its programs except for interest payments on the public debt. High interest rates increased the cost of making payments on government debt. They also decrease government revenues. By deliberately causing unemployment to rise in the name of fighting inflation, high interest rates decrease taxable income and increase the cost of social programs such as Unemployment Insurance and social assistance.

Whenever real (that is inflation adjusted) interest rates are higher than the real rate of economic growth, the government’s debt grows faster than it can be contained through spending cuts. (Stanford 1999:199-203)

The AFB consistently demonstrates that a lower interest rate policy can stimulate demand and create jobs without pushing inflation above the 3% ceiling set by the Bank of Canada.

What allowed Canada to move from annual budget deficits to surpluses was not any change of monetary policy. Rather it was international events, including ironically decisions by the US Federal Reserve Board to defy IMF advice and keep interest rates low, that allowed Canadian rates to fall.

The financial crises that unfolded during 1997 and 1998 could have been immeasurably worse had the US Federal Reserve Board followed the IMF’s advice. An increase in US interest rates might have led to a global depression as effective demand for goods and services was already low in most parts of the world. HigherUS rates also would have accelerated capital flight from financially fragile economies.

The refusal of the USA’s central bank, the Federal Reserve Board, to comply with the IMF’s instructions was a key reason why the Bank of Canada was able to keep interest rates from rising despite the crises in Asia, Russia and Brazil.

On July 28, 1997 just a month after the Thai devaluation set off the Asian crisis, the IMF advised the USA to undertake “a moderate and pre-emptive tightening” of credit policy to forestall inflation. (Phillips 1999) Fortunately, the Fed ignored this advice and kept rates steady. Had they raised rates at that point the Asian crisis would have been much worse as even more capital would have fled Asia and perhaps other so-called “emerging markets” in Latin America and Eastern Europe.

Then on Aug. 3, 1998, 2 weeks before Russia defaulted on its debts and sent money markets into a panic, the IMF again advised “a tightening of (US) monetary policy”. (Phillips 1999) The Fed again refused to comply.

Then after the panic caused by Russia’s default and the failure of a huge private speculative investment fund called Long Term Capital Management, the Federal Reserve Board moved decisively to lower interest rates three times in 6 weeks. The Bank of Canada followed in step lowering its rates by three quarters of a percentage point between August and November of 1998.

The actions of the Federal Reserve Board and the Bank of Canada responded to a very real fear that the world economy was on the verge of falling into a recession or even another Great Depression. Their willingness to take this decisive action was motivated by fear for the stability of the global financial system. Their swift action contrasted markedly with the slowness with which the Bank of Canada acted in the early 1990s when high interest rates were driving thousand of Canadians into unemployment while inflation was falling rapidly.

The US decision to lower interest rates reduced incentives for hot money traders to abandon other countries in favour of a “safe haven” in the USA. It also took pressure off the Bank of Canada to raise Canadian rates. The Bank’s Governor, Gordon Thiessen, kept Canadian rates low enough to allow the economic recovery to continue and a fiscal surplus to grow, making renewed spending on social development once again a possibility.

Although Martin’s spending cuts were an important factor in eliminating the federal deficit they were not as important as the decline in interest rates. A study prepared for the 1998 Alternative Federal Budget by Canadian Auto Workers’ economist Jim Stanford shows that the growth resulting from lower interest rates was a more important factor in bringing about deficit reduction between 1995 and 1997 than were all Martin’s spending cuts. (AFB 1998)

Bibliography

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