Thursday, November 23, 2006

The Fiscal and Economic Update 2006

Overall, I give it an A-. Obviously, that is assuming all projections by the update are accurate.

What I like:

- Retire the national debt by 2021. In fact, the government is speeding up the process two years ahead of the Liberals' plan (see Budget 2005). The Liberals' plan was drop the debt-to-GDP ration to 25% by 2014-2015, where the new plan is to achieve the same level by 2012-2013.
- Increase productivity by lowering corporate tax.
- Lowering personal income tax.
- Renew the Inflation-Target Agreement with the Bank of Canada.

What I concern:

- Some unexpected cost (i.e. health care cost will rack up when baby-boomers start retiring) may arise down the road. After all, 15 years is still some time away.
- Will the government freeze or cut programs to increase surplus, hence speed-up debt repayment?

What I dislike:

- Cutting the GST to 5%.

Consumption tax is the lesser evil comparing to income and corporate tax. You can find a good explanation here (thanks to Greg Mankiw).

On the other hand, there are exceptions. One of them would be the Alabama scenario back in 2003. You can find more if you google "The Riley Plan". The short version of the story is revenue from consumption tax is hard to project, and relying heavily on consumption tax revenue will create budgetary problems for governments.

Finally, a bit of counter-spin here. From the press release of the "Canada's New Government Renews Inflation-Target Agreement With the Bank of Canada":

“Maintaining low, stable and predictable inflation goes right to the bottom line of every household budget,” said Minister Flaherty. “It ensures affordable mortgage rates, allows more families to purchase new homes, secures the value of incomes and keeps the costs of purchases stable.”

From the Phillip's curves, we know that there is a trade-off between controlling inflation and short-term unemployment. To be more explicit, short-term unemployment will go up when the central bank is trying to control inflation by increasing interest rate. This can be proved by the "Zero-Inflation Policy", implemented by John Crow when he was the Governor of the Bank of Canada (hence deepened the recession in the early 90s).

Now, to control inflation (when the economy is over-heated), the central bank will have to increase interest rate. Increasing the Bank Rate will increase mortgage rates. This begs the question, if inflation is on the uprise and the Bank of Canada have to control it by increase the interest rate, how can we still have low interest rate (and low mortgage rate)???

Other than this stupid media spin, I like this update a lot - which is all it matters.


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