How to Curb Alberta's Inflation?

I know for a fact that some of my Alberta friends would not like this idea. However, I think David Dodge and Peter Lougheed were right about creating a trust fund to save those extra oil revenue for future generations.

So, some of you may ask why is it a good idea, and how does this work?

Well, we need to know that the country's inflation is going up moderately - mainly driven by Alberta. The central bank can curb the inflation rate by rising interest rate (aka the Bank rate). However, the current rate is serving very well for most regions in Canada, as inflation is very mild all across the country, except Alberta.

Jacking up the interest rate will affect the whole country. Canada is experiencing an economic slowdown in September and the coming months, except Alberta. To hike up the interest rate just to curb inflation in Alberta will dampen economic growth for the rest of the country, and is not a good nation-wide policy.

Inflation in Alberta is mainly caused by high economic growth - by oil revenue. To make inflation under control in Alberta, the government will have to dampen economic growth. In other words, lowering their GDP growth will do it. The national income (GDP) is calculated by the following:

National Income (Y) = Household Consumption (C) + Private Investment (I) + Government Expenditure (G) + Net Export (NX)

Putting oil revenue in a trust fund will lower G, hence, lower the growth of Y.

Now, some other would say that Alberta can create a trust fund and invest in other provinces. My take is that would be a bad idea. Why?

Because that will hike up inflation in other regions of the country, and in the end, it would not do much good if the policy is to curb the nation's inflation rate.

That is why Norway has been investing their reserves in foreign countries rather than in domestic projects.

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Too much, too fast: Can Alberta learn from Norway?

Soaring revenues, rising inflation and an uncertain future. A province wonders if a country has the answers, writes HEATHER SCOFFIELD

HEATHER SCOFFIELD

ECONOMICS REPORTER,

Yesterday's inflation data highlighted a problem that has engulfed Canada for the past year: Prices rose at a 0.7-per-cent pace on a national level, but in Alberta, where the global commodities boom has set the provincial economy on fire, inflation was up 3.7 per cent.

The disparity holds true for almost every economic statistic, as Alberta's fortunes surge while Central Canada and the East plod along listlessly, ground down by high energy prices, a strong dollar and now, a U.S. slump.

And since monetary policy looks to national levels of inflation, and doesn't take into account that Alberta's economy-on-steroids distorts national figures, interest rates have risen over the past year, mainly to quell the Alberta inflation fire.

Now, there's a partial solution blowing in the wind -- all the way from Norway.

A consensus is forming among economic and political leaders that Alberta could learn from a successful and time-tested Norwegian fiscal policy of setting aside all its oil and gas revenue and investing it outside the country.

Top economists, provincial politicians, and even Bank of Canada Governor David Dodge have closely examined the Norway model, and the idea, in various shapes and forms, is gaining traction as a way to put Alberta's economy on an even keel and allow future generations to benefit from today's bounty.

"I don't think it's much of a quantum shift to say, let's enact this," said Ken Kobly, chief executive officer of the Alberta Chambers of Commerce.

Mr. Dodge recognized the Norway model this week as an "appropriate" option for an economy overwhelmed with energy revenue. While he stopped short of publicly endorsing it for Alberta, sources say he sees much merit in it. And the central bank has made it clear that the solution to Alberta's overheating lies in Alberta's fiscal policy.

". . . The fundamental point is that when you have unexpected increases in revenue, whether you stick them in a separate fund or whether you simply allow the surplus to increase, that is the appropriate stabilization measure to be taking," Mr. Dodge said Thursday at a press conference. He did not explain further.

Norway, the world's third-largest crude oil exporter, has set up a special fund to stabilize the economy today and make sure oil revenue works for the country's future.

Norway puts all of its oil and gas revenue, plus earnings from its state oil and gas interests, into the fund every year. All of the fund is invested outside the country in stocks and bonds, and interest earned in the fund is reinvested. Only 4 per cent is made available for government spending.

Norway's Petroleum Fund, worth more than $250-billion (U.S.), serves a dual purpose. By investing all government earnings from non-renewal natural resources, the government ensures an income flow for the country even after the earnings abate. And by removing the windfall from the country's books and economy, the fund imposes an immediate and strict fiscal discipline on budget makers and removes much of the inflation-fuelling heat that would result from the spending of such revenue.

The result: Growth is strong and steady -- not boom-and-bust, like a typical oil power. Inflation is very low -- unlike in Alberta. Norway's exchange rate does not rise and fall in tandem with oil prices, like Canada's. And the fund is so huge that it could cover all of government spending for two years.

In theory, at least, Canada could use some results like that. Alberta's inflation rate has soared in recent months and has been well above the national average for more than a year. Inflation in most of the rest of the country is well under wraps, and is forecast to average only 0.9 per cent in Ontario next year.

The loonie has soared on Alberta's oil riches, driving down profits and cutting into employment in the manufacturing in Central Canada.

And the country's economy has become so dependent on the spinoffs from oil and gas that many analysts wonder how it will cope when the prices inevitably fall.

So now, leading Alberta politicians and think tanks are proposing Norway-style hybrids for the province. Several of the candidates to replace Ralph Klein as head of the Progressive Conservative Party support a savings plan of some kind. The perceived front runner, Jim Dinning, has been pushing the idea for years, and a proposal to legislate at least 30 per cent of annual oil and gas revenue to the Alberta Heritage Savings Trust Fund is a central plank in his campaign.

"It's lucky money," Mr. Dinning explained yesterday in an interview. "And if we fall into the trap of budgeting on the basis of lucky money, then we're heading toward disaster again."

The Alberta Chambers of Commerce recommended a similar fund in a major report earlier this year.

And the Canada West Foundation, a Calgary-based think tank, has been arguing for Alberta to set aside 50 per cent of its fiscal windfall into the Heritage Fund, to invest for future generations.

In Alaska and Norway, "they've turned their natural resource endowment into a financial endowment for the long term," says Casey Vander Ploeg, a senior policy analyst at the foundation. "That's what we need to do."

Alberta's Heritage Fund was set up in the 1970s and received 30 per cent of resource revenue and kept all earnings. But the province strayed from its plan in the 1980s when oil prices fell, and the fund was essentially capped. Since 1976, Alberta has collected $123-billion in oil and gas revenue, but only 8 per cent of that amount was saved, while 92 per cent was spent, Mr. Vander Ploeg calculates.

If Alberta were to blow off some of its steam by taking the fiscal oil and gas windfall and "sequestering" it from the economy, through foreign investment or some other savings scheme, inflation in the province could well cool off, and growth could be put on a more even, sustainable track, economists argue.

Still, Alberta is not Norway. As a province, rather than a national government, it can't control national monetary or fiscal policy. Its political culture may not support such a savings plan like Norway's population does.

Plus, Alberta's royalty structure is not nearly as generous to the provincial government's coffers as Norway's, leaving relatively less money for the provincial government to stash away. And much of the Norway fund's windfall comes from a state-owned oil company.

Marie Iwanow, a spokeswoman for Alberta Finance, said the Norway model is not a perfect fit for the province.

"It's a country and we are a province."

She said that while the province doesn't have a policy that dictates what percentage of resource revenue has to be injected into the Heritage Fund, Mr. Klein urged last year that about one-third of resource revenue be socked away into several of the province's saving accounts.

Earlier this year, the Klein government also began inflation-proofing the large fund. However, he refused to get rid of a policy that still allows the government to take money from the savings account to pay for program spending.

However, both Mr. Klein and his Finance Minister, Shirley McClellan, have said that increasing the savings is unaffordable because there are so many pressing financial demands on the province's red-hot economy, which is attracting thousands of newcomers every month.

Norway's Petroleum Fund

How did the fund come about? Created by the Norwegian Parliament in 1990 because it believed energy revenues had peaked. The fund was formed to stabilize the current economy and make sure future generations would receive dividends from the country's natural resources.

How does it work? By law, 100 per cent of the Norway government's oil and gas revenues are put into the fund annually. The principle is managed by the central bank, and invested in stocks and bonds outside the country. Net earnings are redeposited into the fund. The annual budget is drawn up excluding oil and gas revenue, and any resulting deficit can be covered off by the fund, as long as it does not exceed 4 per cent of annual deposits.

What are the benefits and disadvantages? The fund is now enormous and generates enough income to support government spending far into the future. Inflation is low, and the currency has decoupled from oil prices, cushioning the country's economy from the ups and downs of global commodity prices. But the fund is always surrounded by political tension, with pressure from opposition parties and parts of the population to spend the money now.

Nov. 30, 2005: $$215.5-billion

1996: $8.04-billion

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The Alberta Heritage Savings Trust Fund

How did the fund come about? Then-premier Peter Lougheed created it in 1976 to save for the future, diversify the economy and improve the province's standard of living. Payments into the fund were abandoned in the 1990s, and only recently has it started to grow again.

How does it work? There is no predetermined contribution required, and deposits are decided on annually. Most of the fund's income has been transferred into the province's general revenues. Investments are handled by the provincial Treasurer, with the mandate to obtain a reasonable return.

What are the benefits and disadvantages? The fund, and many other smaller endowment funds created by the government, have absorbed much of the excess revenue Alberta has found itself with since paying off its debt recently. The funds will pay for various health, education and sustainable development initiatives over the long run. But income flowing into the funds is not steady nor mandated, and long-run benefits for the province as a whole are hard to judge.

Dec. 31, 2005: $14.6-billion

1977: $2.17-billion