## 1. Indicators of Economic Performance

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### Introduction and policy priorities
- Macroeconomic performance at prior consultation was "highly favorable" with policies broadly consistent with Fund advice.
- Central bank actions:
  - Began raising interest rates as output gap closed; later reversed and lowered rates as economy weakened and inflation fell within the 1-3 percent target range.
- Fiscal stance:
  - Geared toward sustaining surpluses and debt reduction despite new spending initiatives and tax cuts.
  - Shift to full accrual accounting raised measured federal surpluses by $3 billion in 2002/03.
- Policy priorities:
  - Near term: accommodative monetary stance given low inflation and limited fiscal countercyclical scope.
  - Medium term: sustain debt reduction and prepare for demographic pressures on retirement and health care systems.
  - Structural reforms: financial sector, labor, trade, and other measures to strengthen productivity and exploit North American market integration.

### Recent developments — growth, labor market, and shocks
- Growth and labor market:
  - 2000–2002 average real GDP growth: 3½ percent.
  - Economy contracted by ¾ percent (annual rate) in 2003Q2 and grew 1 percent in 2003Q3.
  - Unemployment rose to 8 percent before falling to 7½ percent by end-2003.
- Adverse shocks in 2003:
  - SARS outbreak dampened domestic demand and tourism in 2003Q2.
  - One case of BSE in Alberta triggered beef export restrictions.
  - Electrical power blackouts caused a significant production drop in August 2003.
  - Inventory/sales ratio rose above trend; de-stocking lowered growth by 3 percentage points (annual rate) on average in Q2 and Q3.
  - Canadian dollar appreciated over 10 percent in real effective terms during 2003 (elsewhere noted as over 20 percent vs. U.S. dollar from late 2002 to end 2003 and close to 15 percent in real effective terms).

### Sectoral balances and household/firm behavior
- External and current account:
  - Net exports subtracted about 2½ percentage points from growth during the four quarters to 2003Q3.
  - Current account surplus remained over 2 percent of GDP due to improved terms of trade.
- Households:
  - Personal consumption rose by 4¼ percent in 2003Q3 year-on-year.
  - Personal saving rate fell to 1¼ percent; saving rate averaged 5 percent in first half of 2002.
  - Household debt/income ratio around 115 percent.
- Business investment:
  - Business fixed investment grew by about 5¾ percent during the four quarters ending 2003Q3.
  - Purchases of machinery and equipment rose by over 5½ percent in real terms during the four quarters ending 2003Q3.
- Productivity and supply:
  - Since mid-2002, productivity stagnated; unit labor costs accelerated while labor income growth slowed.
  - Labor productivity growth had accelerated to 2 percent during 1996–2002, but remained well below the U.S. rate.

### Financial markets and inflation
- Stock prices rose nearly 20 percent since late 2002 but remained roughly 30 percent below their 2000 peak.
- Net portfolio inflows increased in H1 2003 but eased sharply in Q3 2003.
- Core CPI inflation fell to 1¾ percent after special factors dissipated; Bank of Canada estimated special factors added 1¼ percentage points to 12-month core inflation in early 2003.
- Monetary policy moves:
  - Early 2002 cumulative overnight rate increases: 75 basis points to 2¾ percent.
  - Further tightening in March–April 2003 to 3¼ percent.
  - July and September 2003: returned overnight rates to 2¾ percent.
  - January 20, 2004: Bank lowered target overnight rate by 25 basis points to 2½ percent.

### Medium-term projections (selected series; in percent change from previous period unless otherwise indicated)
- Real GDP: 2001 = 1.9; 2002 = 3.3; 2003 = 1.6; 2004 = 2.7; 2005 = 3.0; 2006 = 2.9; 2007 = 2.8; 2008 = 2.7
- Total domestic demand: 2001 = 1.7; 2002 = 3.4; 2003 = 4.5; 2004 = 3.9; 2005 = 3.0; 2006 = 2.9; 2007 = 2.9; 2008 = 2.8
- Private consumption: 2001 = 2.6; 2002 = 3.4; 2003 = 3.8; 2004 = 3.4; 2005 = 2.2; 2006 = 2.2; 2007 = 2.1; 2008 = 2.0
- Private domestic investment: 2001 = 3.5; 2002 = -0.2; 2003 = 4.5; 2004 = 7.9; 2005 = 4.5; 2006 = 3.9; 2007 = 4.0; 2008 = 3.8
- Net exports (contribution): 2001 = 0.6; 2002 = -0.3; 2003 = -2.6; 2004 = -0.9; 2005 = 0.1; 2006 = 0.1; 2007 = 0.1; 2008 = 0.1
- Unemployment rate (percent): 2001 = 7.2; 2002 = 7.6; 2003 = 7.6; 2004 = 7.1; 2005 = 6.9; 2006 = 6.7; 2007 = 6.5; 2008 = 6.6
- Consumer price index: 2001 = 2.5; 2002 = 2.3; 2003 = 2.7; 2004 = 1.5; 2005 = 2.0; 2006 = 2.0; 2007 = 2.0; 2008 = 2.0
- Federal fiscal balance/GDP: 2001 = 0.6; 2002 = 0.6; 2003 = 0.0; 2004 = 0.2; 2005 = 0.3; 2006 = 0.3; 2007 = 0.4; 2008 = 0.5
- Current account balance/GDP: 2001 = 2.4; 2002 = 2.0; 2003 = 2.0; 2004 = 1.5; 2005 = 1.5; 2006 = 1.4; 2007 = 1.4; 2008 = 1.4
- Memoranda:
  - Partner country growth: 2001 = 0.4; 2002 = 2.4; 2003 = 2.9; 2004 = 4.1; 2005 = 3.6; 2006 = 3.4; 2007 = 3.2; 2008 = 3.1
  - Oil prices ($/Barrel): 2001 = 24.3; 2002 = 25.0; 2003 = 29.0; 2004 = 28.0; 2005 = 25.0; 2006 = 24.0; 2007 = 23.5; 2008 = 23.5

### Short-term outlook and risks
- Staff projections:
  - GDP growth to pick up from around 1½ percent in 2003 to 2¾ percent in 2004, initially supported by turnaround in inventory investment.
  - External drag expected to wane as U.S. economy strengthens and lagged effects of currency appreciation fade.
  - Household consumption and residential investment supported by low interest rates and recent tax cuts; saving rate expected to rise modestly.
  - Business fixed investment expected to benefit from low interest rates and recovery.
  - Bank of Canada would begin withdrawing stimulus by end-2004 as output gap starts closing, keeping inflation close to 2 percent.
- Key risks:
  - Principal uncertainty: impact of Canadian dollar appreciation on net exports; downside if further appreciation occurs amid U.S. fiscal/external imbalances.
  - Domestic risks: unusually low household saving rate, waning stimulus from low interest rates and tax cuts, weakening labor market, possible slowing of residential house prices.
  - Countervailing factors: household balance sheets viewed as sound; housing prices not seen significantly out of line; healthy corporate balance sheets; lower cost of capital imports; pent-up demand supportive of investment.
- Uncertainty about slack:
  - Bank of Canada conventional measures placed output gap around ½ percent of GDP, but other indicators suggested larger slack.
  - Bank’s potential output measure 50 percent confidence interval spans 2 percentage points.

### Monetary policy, exchange rate, and inflation framework
- Inflation-targeting framework seen as successful in guiding policy, achieving low inflation, and promoting transparency and accountability.
- Complicating factors: shocks to administered prices blurred core inflation signals; uncertain exchange rate pass-through.
- Monetary Conditions Index: includes short-term interest rates and nominal effective exchange rate; the exchange rate appreciation tightened overall monetary conditions in 2003.
- Assessment of exchange rate:
  - Strength partly reflects weakness of U.S. dollar and appears consistent with fundamentals given current account surplus, improved net foreign liability position, and world commodity price developments.
  - Authorities commit to exchange rate flexibility; authorities may intervene to maintain orderly conditions.

### Fiscal position, sustainability, and recommendations
- Short-term fiscal picture:
  - Federal surplus likely to be virtually erased in 2003/04; federal surplus was C$7 billion (½ percent of GDP) in 2002/03.
  - Provinces projected a sizable deficit in 2003/04 reflecting health care pressures and SARS/BSE costs; provinces delayed tax cuts and announced spending cuts.
- Fiscal policy recommendations:
  - Macroeconomic policies should remain supportive; fiscal policy should focus on sustained debt reduction and structural reforms to boost productivity.
  - Principal responsibility for cyclical recovery lies with monetary authorities given limited fiscal maneuver.
  - Near-term emphasis on expenditure control rather than broad-based tax cuts; near-term new measures should be modest and accompanied by offsetting broadening of tax base or expenditure cuts.
  - Demonstrate commitment to achieving planned contingency reserve and rebuild economic prudence factor.
- Pensions and age-related programs:
  - Public pension system generally sound; options discussed include improving actuarial fairness of CPP adjustments for early/late retirement and gradual increases in retirement age.
- Longer-term fiscal anchor:
  - Suggest complementing two-year planning with a clearer longer-term debt objective or commitment to a specific fiscal surplus over the cycle.

### Financial system resilience and regulatory reform
- Canada’s financial system assessed as stable and highly advanced; among soundest in the world.
- Recommendations to remain competitive:
  - Transparent guidelines to allow bank mergers where no compelling public-interest concern exists.
  - Harmonization of securities market regulation and legislation; eventual creation of a single regulator would support competitiveness.
  - Strengthen disclosure requirements and rules governing contribution holidays for defined-benefit pension plans; harmonize federal-provincial regulation and supervision.
  - Introduce capital requirements for guarantees in life insurance segregated funds (completed by end-2001) and OSFI powers to remove unsuitable directors/senior officers (brought Canada into full compliance with Basel Core Principles).

### Box 1 — The Decline in the Canadian Personal Saving Rate (summary)
- Recent levels:
  - Saving rate averaged 5 percent of disposable income in first half of 2002.
  - Saving rate fell to around 1¼ percent in 2003Q3.
- Long-term drivers (Bank of Canada estimates): lower real interest rates; lower expected inflation; improved fiscal position; boom in asset prices (household net wealth well over 500 percent of disposable income).
- Broader measure:
  - A broader saving measure (change in household net worth) is about 15 percentage points higher than national accounts measure and remained broadly stable since mid-1990s despite national accounts measure declining.
- Equilibrium estimates and staff analysis:
  - Long-run relationship between saving rate and wealth/income ratio, expected inflation, real interest rate, and general government deficit/GDP suggests a saving rate in range of 4-5 percent.
- Retirement provisioning:
  - 2001 Statistics Canada study: roughly one-third of households not saving enough to replace two-thirds of pre-retirement income, even accounting for Canada Pension Plan benefits.
  - Department of Finance analysis: retirees largely maintained pre-retirement living standards; current saving rates among younger households consistent with historical life-cycle patterns.

### Box 3 — Labor and Capital Taxes in Canada (summary)
- Tax reforms:
  - Federal five-year tax reduction plan launched in 2000 lowered statutory personal and corporate rates, increased contribution limits for tax-deferred retirement savings, and cut capital taxes; some provinces also lowered marginal tax rates.
- Labor taxes:
  - Average effective tax rate on labor remains high, especially relative to the United States.
  - Canada–U.S. gap in labor taxation mainly from higher marginal personal income tax rates in Canada, estimated 6-10 percentage points higher than U.S.
  - Combined effects (including consumption taxes) place total tax wedge closer to European average than U.S.
  - Example highlight: at certain income levels, a single earner with two children in Ontario faces combined federal and provincial effective marginal tax rate slightly above 60 percent, mainly due to clawback on child tax benefits.
- Capital taxes:
  - Effective tax rates on capital lowered but still appear high relative to U.S. and other major countries.
  - 2000 tax reform reduced federal statutory corporate income tax rate from 28 percent in 1999 to 21 percent in 2004.
  - Capital tax scheduled to be eliminated by 2008.
  - Mintz and Chen (2003) estimate Canada’s effective corporate tax rate will still be 5½ percentage points higher than U.S. in 2006, reflecting more generous U.S. depreciation allowances.
- Policy considerations:
  - Continue reforms to reduce but acknowledge that international tax competitiveness gaps may persist into mid-2000s.
  - Consider distributional and labor-market effects of high marginal tax rates and clawbacks; review depreciation and investment tax provisions to shape investment incentives.

### Trade, environment, and other policy issues
- FTAA negotiations:
  - Authorities concerned shift toward narrower agreements could encourage bilateral deals; Canada may be disadvantaged relative to U.S. in bilateral market-access bargaining, including financial services.
  - Ministerial outcome: renewed commitment to conclude FTAA by January 2005 with allowance for "different levels of commitments".
- Kyoto Protocol and GHG policy:
  - Work begun on a tradable permit system and fiscal incentives; measures deemed insufficient to reach 29 percent reduction in GHG emissions by 2010 without significant fiscal costs or larger output loss than the 0.4 percent drop in GDP relative to baseline in 2010 estimated by authorities.
  - Mission recommended considering other instruments such as energy-related consumption taxes; officials noted political constraints and regional burden concerns.
- Official development assistance:
  - Canada’s ODA rose to 0.28 percent of GNP in 2002; authorities committed to doubling spending in dollar terms by end of decade.

### Staff appraisal and Executive Board assessment (summaries)
- Staff appraisal:
  - Strong monetary and fiscal framework and structural reforms since early 1990s enabled flexible response to shocks and foundation for recovery.
  - Downside risks remain, especially dollar strength weighing on net exports and profitability.
  - Near-term prospects broadly favorable; growth likely to rebound underpinned by household spending and business investment.
- Executive Board:
  - Commended monetary and fiscal framework, transparency of inflation targeting.
  - Welcomed Bank of Canada rate cuts and noted potential room for further cuts if needed.
  - Urged fiscal prudence: no need for broad-based tax cuts; focus on rebuilding budgetary reserves and expenditure control.
  - Recommended further measures on health care cost containment, simplification of equalization payments, pension reform options (actuarial fairness, gradual rise in retirement age), harmonization of securities regulation, and review of Employment Insurance to consider experience-rated premiums.

### Selected fiscal, external, and financial indicators (selected series as reported)
- Federal government (PA basis, in billions):
  - Revenue: 140.9; 152.1; 156.1; 166.1; 182.7; 171.7; 177.6; 180.4; 186.0; 195.0; 203.8; 213.3; 223.8
  - Program spending: 102.3; 106.9; 110.0; 109.6; 118.7; 125.0; 133.3; 144.4; 147.8; 156.2; 163.6; 171.6; 179.6
  - Interest payments: 47.3; 43.1; 43.3; 43.4; 43.9; 39.7; 37.3; 36.1; 35.5; 35.3; 36.1; 36.0; 35.9
  - Net federal debt (in billions): 562.9; 560.7; 557.9; 543.7; 524.6; 517.5; 510.6; 510.7; 507.9; 504.4; 500.3; 494.5; 486.2
- General government (NIA/calendar year basis, in billions):
  - Revenue: 363.3; 390.7; 404.7; 428.9; 469.8; 471.4; 475.4; 489.4; 506.1; 527.7; 551.7; 576.7; 603.3
  - Expenditure: 386.7; 389.0; 404.0; 413.1; 437.1; 456.0; 466.5; 486.2; 504.1; 523.8; 546.1; 569.2; 592.9
  - Net public debt (in billions): 751.6; 757.8; 760.0; 735.1; 696.1; 654.5; 647.5; 644.3; 642.3; 638.4; 632.9; 625.4; 615.0
- External sector (selected):
  - Current account balance (in percent of GDP): 2.4; 2.0; 2.0; 1.5; 1.5; 2.4; 2.2; 1.8; 1.7; 2.3; 1.7; 2.4; 1.6; 1.5; 1.4; 1.4; 1.5
  - Merchandise trade balance (in billions): 25.7; 23.8; 42.0; 67.8; 70.9; 57.8; 64.7; 54.9; 61.9
  - Net external investment position (in billions): -290; -300; -244; -197; -189; -184
- Financial sector indicators:
  - Official reserves (in billions of U.S. dollars): 23.4; 28.6; 32.4; 34.2; 37.2; 35.9; 36.7; 36.7
  - Broad money (M3) to FX reserves (percent): 17.1; 14.5; 13.8; 13.2; 12.8; 14.2; 15.5; 15.8
  - General government gross debt (percent of GDP): 116.2; 110.8; 101.8; 99.6; 96.0
  - Banking indicators:
    - Total loans to assets (percent): 62.1; 58.4; 58.7; 57.7; 55.8; 54.5; 55.0; 54.1
    - Impaired assets/total assets: 0.66; 0.60; 0.59; 0.60; 0.84; 0.90; 0.90; 0.83; 0.83
    - Total capital ratio: 10.6; 11.7; 11.8; 12.2; 12.2; 12.4; 12.5; 12.5
    - Tier 1 capital ratio: 7.3; 8.4; 8.4; 8.8; 9.0; 9.2; 9.4; 9.4

### Statistical robustness and data issues
- Canada’s data quality, coverage, periodicity, and timeliness considered excellent for Article IV consultation and surveillance.
- Canada subscribed to the Fund’s SDDS; metadata posted on DSBB.
- Statistics Canada, Department of Finance, and Bank of Canada provide comprehensive real, fiscal, monetary, and external sector data.
- Noted improvements and recommendations from ROSC/FSSA and Fiscal Transparency assessments; many issues being addressed.

*Source: IMF staff report chapter "1. Indicators of Economic Performance" (pages excerpted).*

### 1. Indicators of Economic Performance...........................................................................26

### 1. Indicators of Economic Performance

### Introduction
- At last year’s consultation, Canada’s macroeconomic performance was highly favorable and policies were broadly consistent with past Fund advice (Appendix I).
- The central bank had begun to raise interest rates as the output gap was closing; fiscal policy remained geared toward sustaining surpluses and debt reduction despite new spending initiatives and tax cuts.
- Over the past year, a series of negative shocks slowed the economy sharply in H2 2002 and into 2003, and increased public health outlays eroded federal fiscal surpluses.
- With the economy weakening, the Canadian dollar appreciating sharply, and inflation falling within the 1-3 percent target range, the Bank of Canada reversed course and lowered interest rates.
- Policy priorities emphasized:
  - Near term: an accommodative monetary stance given low inflation and limited fiscal countercyclical scope.
  - Medium term: sustain debt reduction and prepare for demographic pressures on retirement and health care systems.
  - Structural reforms: financial sector, labor, trade, and other measures to strengthen productivity and exploit North American market integration.

### Recent Developments
- Growth performance and labor market:
  - 2000–2002 average real GDP growth: 3½ percent.
  - The economy contracted by ¾ percent (annual rate) in 2003Q2 and grew 1 percent in 2003Q3.
  - Unemployment rose to 8 percent before falling to 7½ percent by end-2003.
- Shocks that weighed on activity:
  - SARS outbreak dampened domestic demand and tourism in 2003Q2.
  - One case of BSE in Alberta triggered beef export restrictions.
  - Electrical power blackouts caused a significant production drop in August 2003.
  - Inventory/sales ratio rose above trend, prompting de-stocking and lowering growth by 3 percentage points (annual rate) on average in Q2 and Q3.
  - Canadian dollar appreciated over 10 percent in real effective terms during 2003.
- Sectoral contributions and balances:
  - Net exports subtracted about 2½ percentage points from growth during the four quarters to 2003Q3.
  - Current account surplus remained over 2 percent of GDP due to improved terms of trade from higher world commodity prices.
  - Personal consumption rose by 4¼ percent in 2003Q3 from the same period in 2002; personal saving rate fell to 1¼ percent.
  - Household debt/income ratio reached around 115 percent.
  - Business fixed investment grew by about 5¾ percent during the four quarters ending in 2003Q3.
- Supply side and productivity:
  - Since mid-2002, productivity has been stagnant; unit labor costs accelerated while labor income growth slowed.
  - Labor productivity growth had accelerated to 2 percent during 1996–2002, but remained well below the U.S. rate.
- Financial markets and inflation:
  - Stock prices rose nearly 20 percent since late 2002 but remained roughly 30 percent below their 2000 peak.
  - Net portfolio inflows increased in H1 2003 but eased sharply in Q3 2003.
  - Core CPI inflation fell to 1¾ percent after special factors dissipated; Bank of Canada estimates indicated special factors added 1¼ percentage points to 12-month core inflation in early 2003.
- Monetary policy actions in 2002–2003:
  - Early 2002 cumulative overnight rate increases: 75 basis points to 2¾ percent.
  - Further tightening in March–April 2003 to 3¼ percent.
  - July and September 2003: returned overnight rates to 2¾ percent.
- Fiscal position:
  - The room for fiscal maneuver narrowed; the federal surplus was likely to be virtually erased in 2003/04.
  - The shift to full accrual accounting raised measured federal surpluses by $3 billion in 2002/03.
  - Provinces projected a sizable deficit in 2003/04 reflecting health care pressures and SARS/BSE costs; responses included delaying tax cuts and announcing spending cuts.

### Medium-Term Projections (selected series; in percent change from previous period unless otherwise indicated)
- Projections (selected years and series as presented):
  - Real GDP: 2001 = 1.9; 2002 = 3.3; 2003 = 1.6; 2004 = 2.7; 2005 = 3.0; 2006 = 2.9; 2007 = 2.8; 2008 = 2.7
  - Total domestic demand: 2001 = 1.7; 2002 = 3.4; 2003 = 4.5; 2004 = 3.9; 2005 = 3.0; 2006 = 2.9; 2007 = 2.9; 2008 = 2.8
  - Private consumption: 2001 = 2.6; 2002 = 3.4; 2003 = 3.8; 2004 = 3.4; 2005 = 2.2; 2006 = 2.2; 2007 = 2.1; 2008 = 2.0
  - Private domestic investment: 2001 = 3.5; 2002 = -0.2; 2003 = 4.5; 2004 = 7.9; 2005 = 4.5; 2006 = 3.9; 2007 = 4.0; 2008 = 3.8
  - Net exports (contribution): 2001 = 0.6; 2002 = -0.3; 2003 = -2.6; 2004 = -0.9; 2005 = 0.1; 2006 = 0.1; 2007 = 0.1; 2008 = 0.1
  - Unemployment rate (percent): 2001 = 7.2; 2002 = 7.6; 2003 = 7.6; 2004 = 7.1; 2005 = 6.9; 2006 = 6.7; 2007 = 6.5; 2008 = 6.6
  - Consumer price index: 2001 = 2.5; 2002 = 2.3; 2003 = 2.7; 2004 = 1.5; 2005 = 2.0; 2006 = 2.0; 2007 = 2.0; 2008 = 2.0
  - Federal fiscal balance/GDP: 2001 = 0.6; 2002 = 0.6; 2003 = 0.0; 2004 = 0.2; 2005 = 0.3; 2006 = 0.3; 2007 = 0.4; 2008 = 0.5
  - Current account balance/GDP: 2001 = 2.4; 2002 = 2.0; 2003 = 2.0; 2004 = 1.5; 2005 = 1.5; 2006 = 1.4; 2007 = 1.4; 2008 = 1.4
- Memorandum items:
  - Partner country growth: 2001 = 0.4; 2002 = 2.4; 2003 = 2.9; 2004 = 4.1; 2005 = 3.6; 2006 = 3.4; 2007 = 3.2; 2008 = 3.1
  - Oil prices ($/Barrel): 2001 = 24.3; 2002 = 25.0; 2003 = 29.0; 2004 = 28.0; 2005 = 25.0; 2006 = 24.0; 2007 = 23.5; 2008 = 23.5
- Sources: Fund staff estimates; and Statistics Canada.

### The Short-Term Outlook
- Staff projection summary:
  - GDP growth projected to pick up from around 1½ percent in 2003 to 2¾ percent in 2004, initially supported by a turnaround in inventory investment.
  - Drag from the external sector expected to wane into 2004 as a strengthening U.S. economy offsets the lagged effects of the Canadian dollar appreciation.
  - Household consumption and residential investment supported by low interest rates and recent tax cuts; saving rate expected to rise modestly.
  - Business fixed investment expected to benefit from low interest rates and the recovery.
  - With the output gap starting to close in 2004, the Bank of Canada would begin withdrawing stimulus by end-year, keeping inflation close to 2 percent.
- Risks discussed:
  - Principal uncertainty: impact of the Canadian dollar appreciation on net exports; official and consensus forecasts viewed the impact as more modest than conventional elasticities imply.
  - Factors potentially mitigating exchange rate effects: appreciation partly reflecting higher world commodity prices; reduced pass-through of exchange rates to import prices; businesses’ expectations that the Canadian dollar had been undervalued in 2002.
  - Downside risk: further appreciation of the Canadian dollar in the face of large U.S. fiscal and external imbalances could trigger a sharper drop in net exports and weaker growth.
  - Domestic risks: unusually low household saving rate, waning stimulus from low interest rates and tax cuts, weakening labor market conditions, and possible slowing of residential house prices.
  - Countervailing considerations: household balance sheets viewed as sound; housing prices not seen significantly out of line with fundamentals; healthy corporate balance sheets, lower cost of capital imports, and pent-up demand supportive of investment.
- Uncertainty about economic slack:
  - Bank of Canada conventional measures placed the output gap at around ½ percent of GDP, but capacity utilization, unemployment, and falling inflation suggested larger slack.
  - The Bank’s potential output measure has a 50 percent confidence interval that spans 2 percentage points.

### Monetary Policy and the Exchange Rate
- Assessment of the inflation-targeting framework:
  - Officials and the mission agreed the framework successfully guided monetary policy, achieved low inflation, and promoted transparency and accountability.
  - The uncertain macroeconomic environment complicated policymaking: shocks to administered prices blurred core inflation signals; uncertain effects of increased credibility on inflation dynamics and the inflation/output tradeoff.
  - Exchange rate pass-through appeared diminished, but robustness to a large shock remained unclear.
  - Bank officials emphasized these uncertainties did not argue for less reactive monetary policy and highlighted increased anchoring of inflation expectations and greater household access to credit markets as factors increasing the economy’s responsiveness to interest rates.
- Monetary conditions indicators and policy stance:
  - Monetary tightening in early 2002 and March–April 2003 raised overnight rates to 3¼ percent before easing back to 2¾ percent by September 2003.
  - Monetary Conditions Index measures include weighted averages of changes in short-term interest rates and the nominal effective exchange rate; the exchange rate’s appreciation tightened overall monetary conditions in 2003.

*Source: IMF staff report chapter "1. Indicators of Economic Performance" (pages excerpted).*

### Box 1. The Decline in the Canadian Personal Saving Rate

### Box 1. The Decline in the Canadian Personal Saving Rate

### Recent decline in the personal saving rate
- The saving rate averaged 5 percent of disposable income in the first half of 2002.
- The saving rate fell to around 1¼ percent in the third quarter of 2003—an historic low and significantly lower than even the U.S. saving rate.
- The decline must be seen against a secular fall that began in the mid-1980s.

### Long-term drivers identified by Bank of Canada estimates
- Four factors suggested as contributing to the long-term decline:
  - Lower real interest rates sharply reduced the return on household wealth.
  - Lower expected inflation decreased uncertainty and the need for precautionary saving.
  - The improvement in the fiscal position lowered the need to save for future tax liabilities.
  - The boom in asset prices during the 1990s increased household net wealth to well over 500 percent of disposable income, reducing the need for further asset accumulation.
- Historical reference: The saving rate had reached 20 percent of GDP in 1982, but fell steadily thereafter.

### Alternative (broader) saving measure and capital gains
- The national accounts measure of the saving rate may be misleading given large capital gains in recent years.
- A broader measure of the saving rate, derived from the change in household net worth, is about 15 percentage points higher than the national accounts measure.
- The broader measure followed the same trend as the national accounts saving rate until the mid-1990s, but thereafter remained broadly stable while the national accounts measure continued to decline.
- This divergence reflects strong returns on household assets that provided capital gains to finance current consumption while further adding to net wealth.

### Equilibrium estimates and staff analysis
- Staff estimates suggest a long-run relationship exists between the saving rate and the wealth/income ratio, expected inflation, the real interest rate, and the general government deficit/GDP ratio.
- These variables would suggest a saving rate that is in the range of 4-5 percent, well above recent levels.

### Retirement provisioning and distributional concerns
- A 2001 study by Statistics Canada suggested that roughly one-third of households were not saving enough to replace two-thirds of their pre-retirement income, even taking into account benefits from the Canada Pension Plan.
  - Many of these households were at the upper end of the income distribution, but shortfalls were also significant at the low end.
- Contrasting analysis by the Department of Finance:
  - Their analysis of individual household consumption data suggests that retirees have by and large been able to maintain pre-retirement living standards.
  - Current saving rates among younger households have remained consistent with historical life-cycle patterns.

*Source: Box 1. The Decline in the Canadian Personal Saving Rate, _cr0461 - Box 1. The Decline in the Canadian Personal Saving Rate*

### Box 3. Labor and Capital Taxes in Canada

### Box 3. Labor and Capital Taxes in Canada

### Overview
- With the emergence of fiscal surpluses, significant tax reductions have taken place in Canada, including a federal five-year tax reduction plan launched in 2000 that significantly lowered statutory tax rates on personal and corporate income, increased contribution limits for tax-deferred retirement savings plans, and cut capital taxes. Some provinces have also lowered marginal income tax rates for households and businesses.
- Despite these reforms, effective tax burdens on labor and capital remain substantial in international comparison.

### Labor taxes — findings and implications
- The average effective tax rate on labor in Canada remains high, especially compared to the United States.
- The Canada–U.S. gap in labor taxation stems mainly from higher marginal personal income tax rates in Canada, which are estimated to be 6-10 percentage points higher than in the United States, more than offsetting the lower rate paid for social security in Canada.
- When accounting for the higher tax rate on consumption, the total tax wedge on labor in Canada is closer to the European average than to the United States.
- Canada’s relatively progressive personal income tax system combined with high clawback rates on transfers and tax credits produces high marginal tax rates for low- and middle-income families.
  - Example: At certain income levels, a single-earner with two children in Ontario faces a combined federal and provincial effective marginal tax rate slightly above 60 percent, mainly due to the clawback rate on child tax benefits.
- Effective marginal tax rate schedule (Federal/Ontario, single earner couple w/ two children) shown in source chart (Employment Income in C$ on horizontal axis; % on vertical axis).

### Capital taxes — findings and projections
- Effective tax rates on capital have been lowered but still appear high relative to the United States and many other major industrialized countries, based on calculations using National Accounts data to derive an effective average tax rate on capital income.
- Planned federal and provincial tax cuts are expected to narrow the gap appreciably.
  - The 2000 tax reform reduced the federal statutory corporate income tax rate from 28 percent in 1999 to 21 percent in 2004.
  - The capital tax is scheduled to be eliminated by 2008.
- Despite these measures, comprehensive comparisons that account for provincial income and capital taxes, investment tax credits, and depreciation allowances indicate ongoing differences:
  - Mintz and Chen (2003) estimate that Canada’s effective corporate tax rate will still be 5½ percentage points higher than in the United States in 2006, in large part reflecting more generous U.S. depreciation allowances.

### Policy considerations and analysis
- Tax reforms to date have materially lowered statutory rates, but:
  - High marginal personal income tax rates and interaction with transfer clawbacks sustain large effective marginal tax rates for certain households.
  - Persistent differences in effective corporate taxation reflect interplay of federal and provincial taxes, tax credits, and depreciation rules.
- Ongoing and planned reforms (federal and provincial) are projected to reduce but not fully eliminate international tax competitiveness gaps by the mid-2000s.
- Implications for policymakers include the need to consider:
  - The distributional and labor-market effects of high marginal tax rates combined with clawbacks on transfers and credits.
  - The role of depreciation and investment tax provisions in shaping effective corporate tax burdens and investment incentives.

*Source: _cr0461 - Box 3. Labor and Capital Taxes in Canada*

### 50.      The authorities expressed concern about the ongoing negotiations for a Free Trade

### _cr0461 - 50.      The authorities expressed concern about the ongoing negotiations for a Free Trade

### FTAA negotiations and bilateral agreements
- Authorities expressed concern about ongoing negotiations for a Free Trade Area of the Americas (FTAA), questioning whether proposals at the November 2003 ministerial to shift negotiations away from a broad-based regional agreement to a more narrowly focused one could encourage countries to place greater emphasis on bilateral agreements.
- Canada was active bilaterally, but officials noted Canada could be at a disadvantage relative to the United States in using bilateral agreements to gain market access, including in the area of financial services.
- The outcome of the ministerial meeting was a renewed commitment to conclude the FTAA by January 2005, but differences on sensitive issues such as agriculture and investment would allow “different levels of commitments” between countries. (Footnote material in source.)

### Kyoto Protocol implementation and GHG policy
- Progress: work begun on a tradable permit system for greenhouse gas (GHG) emissions; various fiscal incentives introduced to support new technologies and conservation.
- Concern: measures thus far did not seem sufficient to achieve the targeted 29 percent reduction in GHG emissions by 2010.
- Authorities’ estimate: achieving the 29 percent target would be difficult without significant fiscal costs or a larger output loss than the 0.4 percent drop in GDP relative to baseline in 2010 estimated by the authorities.
- Mission recommendation: consider other, possibly more efficient, instruments—such as energy-related consumption taxes.
- Officials’ response: such alternatives had been ruled out by the previous administration partly because of concern that their burden would fall too heavily on certain regions; officials viewed economic risks as manageable given the U.S. decision not to ratify the Protocol and contingencies to keep Canada competitive and able to take advantage of future technologies.

### Official development assistance (ODA)
- Canada’s ODA rose to 0.28 percent of GNP in 2002.
- Authorities committed to doubling spending in dollar terms by the end of the decade.
- Spending targeted at countries and projects where effectiveness was most likely to be maximized.

### Statistics and data access
- Mission acknowledged the high quality of Canadian statistical systems, but noted that user charges could constrain analysis.
- Officials: fees charged by Statistics Canada (including to other government agencies) were consistent with broader government policy requiring cost recovery by all government departments; fees waived for educational institutions.

### Staff appraisal — macroeconomic outlook and policy stance
- Assessment: strong monetary and fiscal policy framework and structural reforms since the early 1990s have enabled flexible response to shocks and laid a solid foundation for recovery.
- Risks: downside risks remain, especially the dollar’s strength weighing on net exports and domestic profitability.
- Near-term prospects: broadly favorable, with growth likely to rebound next year underpinned by household spending and a pick up in business investment.

### Fiscal policy recommendations
- Macroeconomic policies should remain supportive; fiscal policy should continue to focus on sustained debt reduction and structural reforms to boost productivity.
- Principal responsibility for fostering cyclical recovery rests with monetary authorities given limited fiscal maneuver under the existing medium-term budgetary framework.
- With erosion of budget surpluses, federal and provincial fiscal authorities need to remain focused on sustaining debt reduction and ensuring retirement and health care systems are prepared for impending demographic pressures.
- Productivity gains are essential for competitiveness and to generate income and saving necessary to cope with population aging; emphasize financial sector, labor, trade, and other structural policy reforms.

### Monetary policy stance
- With an opening output gap, dollar appreciation weighing on activity, and core inflation expected to remain low, monetary policy can remain accommodative for some time.
- Inflation signals clouded by special factors; uncertainty in output gap estimates.
- Credibility of the Bank and indicators suggesting larger economic slack provide room to respond if recovery risks intensify.

### Exchange rate and external adjustment
- Canada’s commitment to exchange rate flexibility has helped adjust global macroeconomic imbalances.
- Strength of the Canadian dollar partly reflects weakness of the U.S. dollar and appears consistent with fundamentals given Canada’s current account surplus, improved net foreign liability position, and world commodity price developments.

### Fiscal sustainability and budgetary framework
- Fiscal framework has left Canada relatively well-positioned for population aging, but short-term fiscal outlook more challenging.
- Economic slowdown and 2003 Budget spending initiatives, particularly health-care related transfers to provinces, have used up much of projected planning surpluses.
- Important to demonstrate commitment to achieving the planned contingency reserve set out in the recent Fiscal Update and to rebuilding the economic prudence factor at the earliest opportunity.
- Difficult issues at federal and provincial levels must be tackled to keep public debt ratio on a downward track.
  - Federal-provincial Health Accord helpful for funding certainty, but scope exists to strengthen incentives to contain costs and usage (including expanding private providers’ role and introducing some cost recovery from patients).
  - Amendments to federal-provincial equalization payments should reduce complexity, avoid excessive year-to-year swings, and contain the burden on the federal budget.

### Near-term fiscal strategy
- Present environment suggests focus on expenditure control rather than broad-based tax cuts.
- Authorities’ comprehensive review of existing programs is welcome.
- Any near-term new measures should be relatively modest and accompanied by offsetting broadening of the tax base or expenditure cuts.

### Pensions and age-related programs
- Public pension system and other age-related programs appear sound but further reforms may be warranted.
- Options discussed: improve actuarial fairness of CPP benefit adjustments for early/late retirement; gradual increases in the retirement age to reflect increases in longevity; these could encourage labor market attachment and possibly enable eventual reduction in the CPP premium rate.
- Increasing retirement age could reduce burden on old-age security system and encourage greater accumulation of private retirement savings.

### Longer-term fiscal anchor
- Government’s fiscal framework could be complemented by a clearer longer-term anchor—for example, a more explicit longer-term debt objective or a commitment to achieving a specific fiscal surplus over the economic cycle to supplement the existing two-year planning framework.

### Financial system resilience and regulatory reform
- Canadian financial system has remained resilient due to strong regulation and effective response to corporate accounting and governance concerns.
- To remain competitive amid global capital market integration:
  - Transparent guidelines needed to allow bank mergers where no compelling public-interest concern exists.
  - Harmonization of securities market regulation and legislation—and eventual creation of a single regulator—would support global competitiveness.
  - Recent weaknesses in defined-benefit pension plans highlight need to strengthen disclosure requirements and rules governing contribution holidays, and further harmonize federal-provincial regulation and supervision.

### Regulatory, social, and trade policy priorities to boost productivity
- Regulatory policies:
  - Deregulation in the electricity sector has been more difficult and costly than expected; ensure consumers are not inappropriately shielded from underlying costs.
  - Achievement of environmental objectives may require instruments such as consumption-related taxes to minimize adverse fiscal and supply-side consequences.
  - Continue efforts to remove interprovincial barriers to trade.
- Social policies:
  - Use of the EI system for broader social policy objectives has resulted in significant cross-subsidization across industries and regions.
  - Pending EI review offers opportunity to consider experience-rated premiums and alternative funding options for social objectives currently supported by the system.
- Trade and agricultural policies:
  - Canada’s trade system remains open and transparent.
  - Easing import barriers further—especially in agriculture—and disciplining use of anti-dumping and countervailing duties would encourage competitive efficiencies and complement Canada’s official development objectives.
  - Canada can play an important leadership role in efforts to bridge differences among participants of the Doha Round.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr0461.pdf*

### 65.      It is recommended that the next Article IV consultation take place within the standard

### _cr0461 - 65.      It is recommended that the next Article IV consultation take place within the standard

### Recommendation on Article IV consultation
- It is recommended that the next Article IV consultation take place within the standard 12-month cycle.
- Last Article IV consultation: the staff report for the 2003 consultation with Canada was considered by the Executive Board on January 31, 2003 (EBM/03/6). Canada is on a 12-month consultation cycle.

### Macroeconomic outlook and key indicators (selected)
- Real GDP (Canada, selected series from tables): 1.9; 3.3; 1.6; 2.7; 3.0; 5.8; 3.8; 2.7; 1.6; 2.0 (series reported in Table 2).
- CPI inflation (y/y, selected): 2.5; 2.3; 2.7; 1.5; 2.0; 1.6; 1.3; 2.3; 3.8; 4.4; 2.9; 2.2; 1.6; 0.9; 1.6; 1.6; 1.8 (series reported in Table 2).
- Current account balance (in percent of GDP, Canada): 2.4; 2.0; 2.0; 1.5; 1.5; 2.4; 2.2; 1.8; 1.7; 2.3; 1.7; 2.4; 1.6; 1.5; 1.4; 1.4; 1.5 (Table 2).

### Fiscal stance and public finances (selected)
- General government fiscal balance (NIA basis, percent of GDP, selected series from Table 2): 1.4; 0.8; 0.3; 0.2; 0.3; 0.4; 0.5; 0.4; 1.4; 1.5; 0.7; 1.0 (series and projections reported).
- Federal government (PA basis, in billions of dollars, Table 5):
  - Revenue: 140.9; 152.1; 156.1; 166.1; 182.7; 171.7; 177.6; 180.4; 186.0; 195.0; 203.8; 213.3; 223.8.
  - Program spending: 102.3; 106.9; 110.0; 109.6; 118.7; 125.0; 133.3; 144.4; 147.8; 156.2; 163.6; 171.6; 179.6.
  - Interest payments: 47.3; 43.1; 43.3; 43.4; 43.9; 39.7; 37.3; 36.1; 35.5; 35.3; 36.1; 36.0; 35.9.
  - Net federal debt (in billions): 562.9; 560.7; 557.9; 543.7; 524.6; 517.5; 510.6; 510.7; 507.9; 504.4; 500.3; 494.5; 486.2.
- General government (NIA/calendar year basis, in billions, Table 5):
  - Revenue: 363.3; 390.7; 404.7; 428.9; 469.8; 471.4; 475.4; 489.4; 506.1; 527.7; 551.7; 576.7; 603.3.
  - Expenditure: 386.7; 389.0; 404.0; 413.1; 437.1; 456.0; 466.5; 486.2; 504.1; 523.8; 546.1; 569.2; 592.9.
  - Net public debt (in billions): 751.6; 757.8; 760.0; 735.1; 696.1; 654.5; 647.5; 644.3; 642.3; 638.4; 632.9; 625.4; 615.0.
- Memorandum fiscal items (Table 5): Real GDP growth series: 1.6; 4.2; 4.1; 5.5; 5.3; 1.9; 3.3; 1.6; 2.7; 3.0; 2.9; 2.8; 2.7.

### External sector and balance of payments (selected)
- Current account balance (Table 3, levels and percent of GDP): -11.4; -11.4; 2.6; 30.7; 26.9; 23.4; 28.3; 20.2; 29.3 (in billions) and -1.3; -1.2; 0.3; 2.9; 2.4; 2.0; 2.3; 1.7; 2.4 (in percent of GDP).
- Merchandise trade balance (in billions): 25.7; 23.8; 42.0; 67.8; 70.9; 57.8; 64.7; 54.9; 61.9.
- Net external investment position (memorandum): -290; -300; -244; -197; -189; -184 (in billions); in percent of GDP: -32.9; -32.8; -24.8; -18.3; -17.1; -15.9.

### Financial sector and vulnerability indicators (selected)
- Official reserves (in billions of U.S. dollars, Table 4): 23.4; 28.6; 32.4; 34.2; 37.2; 35.9; 36.7; 36.7.
- Broad money (M3) to foreign exchange reserves (percent): 17.1; 14.5; 13.8; 13.2; 12.8; 14.2; 15.5; 15.8.
- General government gross debt (percent of GDP): 116.2; 110.8; 101.8; 99.6; 96.0.
- Banking sector indicators (selected):
  - Total loans to assets (percent): 62.1; 58.4; 58.7; 57.7; 55.8; 54.5; 55.0; 54.1.
  - Impaired assets/total assets: 0.66; 0.60; 0.59; 0.60; 0.84; 0.90; 0.90; 0.83; 0.83.
  - Total capital ratio: 10.6; 11.7; 11.8; 12.2; 12.2; 12.4; 12.5; 12.5.
  - Tier 1 capital ratio: 7.3; 8.4; 8.4; 8.8; 9.0; 9.2; 9.4; 9.4.

### Fund relations, assessments, and standards
- Membership status: Joined 12/27/45; Article VIII.
- Quota: 6,369.20 (million of quota, 100.0 percent). Fund holdings of currency: 3,613.07 (56.73). Reserve position in Fund: 2,756.14 (43.27).
- SDR: Net cumulative allocation 779.29 (100.00); Holdings 555.54 (71.29).
- Outstanding Purchases and Loans: None. Financial Arrangements: None. Projected Obligations to Fund: None.
- Exchange rate arrangements: Authorities do not maintain margins; exchange rates determined by demand and supply; authorities may intervene to maintain orderly conditions; no taxes or subsidies on purchases or sales of foreign exchange. Restrictions notified vis-à-vis Iraq and the Federal Republic of Yugoslavia (Serbia and Montenegro).

### FSAP and ROSC findings (selected conclusions and recommendations)
- Canada—Financial System Stability Assessment (FSSA) summary:
  - Conclusion: Canada has a stable and highly advanced financial system, among the soundest in the world, supported by a well-developed regulatory system with high compliance with major international standards.
  - Recommendations (noted as mostly addressed): 
    - Introducing capital requirements for the guarantees in life insurance segregated fund (completed by end-2001).
    - Tabling legislation granting OSFI powers to remove a financial institution’s director or senior officer if deemed not suitable (brought Canada into full compliance with the Basel Core Principles).
    - Progress in harmonizing securities regulation and improving coordination among provincial securities regulators; a Senate commission was created to develop recommendations on harmonization and streamlining.
- Canada: Report on the Observance of Standards and Codes—Fiscal Transparency Module:
  - Findings: Fiscal management meets the requirements of the fiscal transparency code and in several instances represents best practice (use of private sector economic forecasts, prudence factors, contingency reserve).
  - Further improvements desirable (areas identified): (i) timely, current year estimates of federal and provincial budgets on a comparable basis; (ii) comprehensive account of procedures for the budget cycle and expenditure management system; (iii) systematic reporting of the use of reserves for non-economic contingencies; (iv) resume publication of reconciled national and public accounts forecasts; (v) publication by all governments of quasi-fiscal activities.
  - Many issues have been addressed, including release by Statistics Canada of consolidated data for federal and provincial budgets for 2001-02 and publication of descriptions of budget and expenditure management procedures.
- Canada: Report on the Observance of Standards and Codes—Data Module:
  - Conclusion: Macroeconomic statistics are comprehensive, timely, and accurate, adequate for effective surveillance. Institutional frameworks protect confidentiality and ensure quality assurance.
  - Recommendations/priorities (most already being addressed): 
    - Articulate roles of Statistics Canada and the Bank of Canada in producing financial sector statistics and explore more data sharing.
    - Estimate consumption of fixed capital at replacement cost rather than historic costs for the corporate sector in the CSNA.
    - Disseminate information on sources and methods used in compiling quarterly public sector statistics for the quarterly CSNA.
    - Reclassify certain transactions not recorded in line with the 5th edition of the Balance of Payments Manual (BPM5).

### Technical assistance and representation
- Technical assistance: Not applicable.
- Resident Representative: Not applicable.

*Source: Fund staff estimates; IMF, World Economic Outlook; Statistics Canada; Department of Finance Canada; and the text of _cr0461 (selected tables and appendices as provided).*

### APPENDIX                                                                        II

### APPENDIX II

### Statistical Issues
- Canada’s data quality, coverage, periodicity, and timeliness are considered to be excellent for Article IV consultation and ongoing surveillance.
- Canada has subscribed to the Fund’s Special Data Dissemination Standard (SDDS); metadata are posted on the Fund’s Dissemination Standard Bulletin Board (DSBB).
- Real sector: Statistics Canada provides monthly, quarterly, and annual data. In May 2001, Statistics Canada transitioned from Laspeyres methodology to Fisher index formulae for real expenditure-based GDP.
- Fiscal sector: Department of Finance of Canada provides monthly and annual federal budget, tax policy, and regulatory data.
- Monetary sector: Bank of Canada provides daily, weekly, monthly, and quarterly monetary data.
- External sector: Statistics Canada provides monthly, quarterly, and annual balance of payments and international position data. Finance Canada provides monthly Official International Reserves in a format comparable to the IMF’s reserve data template.

*Statement by the IMF Staff Representative on Canada — February 18, 2004*

### Recent economic and financial market developments (Staff summary)
- Output and trade:
  - GDP was essentially flat in November 2003, following 0.1 percent growth in October.
  - November trade surplus fell due to declines in exports of autos and capital goods; imports grew strongly.
- Labor market and households:
  - Retail sales fell ½ percent in November; sales excluding autos rose by 3/4 percent.
  - Employment gains of 50,000 new jobs in both December 2003 and January 2004.
  - Unemployment rate edged down to 7.4 percent; labor force participation reached new record highs in December.
- Inflation:
  - Headline CPI edged up 0.1 percent in December; Bank of Canada’s core measure up 0.2 percent.
  - Year-over-year headline and core inflation rates rose to 2.0 percent and 2.2 percent, respectively, due to base effects from December 2002 Ontario electricity price rebates.
- Monetary policy:
  - On January 20, the Bank of Canada lowered its target overnight rate by 25 basis points to 2½ percent.
  - Bank scaled back growth projection to 2¾ percent in 2004 and 3¾ percent in 2005.
  - Output gap expected to close only by the third quarter of 2005; core inflation projected to fall below 1½ percent in early 2004, then return to 2 percent by end 2005.
  - Three-month treasury bill yields about 25 bps below the Bank’s overnight rate since January 20 announcement.
  - Canadian dollar has fallen by about 4 percent against the U.S. dollar since mid-January.

### Fiscal and other policy developments (Staff summary)
- Throne speech commitments (January):
  - Rebate to municipalities of their payments of Goods and Services Tax at a cost to the federal government roughly of ½ percent of GDP annually.
  - Preserve sustainability of the health care system and work with provinces on reforms and long-term sustainability.
  - Achieve Kyoto Accord goals and increase environmental funding, including a ten-year, $3.5-billion plan to clean up contaminated sites (already included in earlier budget projections).
  - Promote job training and higher education: overhaul Canada Student Loans program, create new grants for postsecondary education, and expand education savings plan benefits for lower-income families.
- Fiscal stance and review:
  - Government reaffirmed commitment to preserving fiscal surpluses.
  - Finance Minister announced freeze on large capital projects, limits on public sector pay rises, and a Cabinet-led review of government program spending.
  - Minister cautioned fiscal position under pressure from economic situation and new priorities, but reiterated commitment to fiscal surpluses and debt reduction.

*Public Information Notice (PIN) No. 04/18 — March 10, 2004*

### Background and macroeconomic assessment (PIN summary)
- Growth and shocks:
  - Canada grew substantially faster than other G7 countries earlier, but growth slowed to 1 percent during the four quarters to 2003Q3.
  - Industrial production sluggish; manufacturing output in November 2003 below its level a year earlier.
  - Contributing adverse factors: SARS outbreak (dampened domestic demand and tourism), one case of BSE in Alberta (restrictions on beef exports), electrical power blackouts (production drop in August), and significant de-stocking in 2003 (inventory/sales ratio above trend; automotive sector subtraction about 3 percentage points on average from annual growth in Q2 and Q3).
  - Exchange rate: domestic currency appreciated by over 20 percent against the U.S. dollar from late 2002 to end 2003, and by close to 15 percent in real effective terms; net exports subtracted about 2½ percentage points from annual GDP growth during the four quarters to 2003Q3.
- Domestic demand:
  - Personal consumption rose by 4¼ percent in 2003Q3 from the same period in 2002.
  - Personal saving rate fell to 1¼ percent.
  - Business fixed investment began to recover; purchases of machinery and equipment rose by over 5½ percent in real terms during the four quarters ending 2003Q3.
- Inflation and output gap:
  - Economy moved from close to potential at end-2002 to roughly 1½ percent below potential by 2003Q3 (staff estimate).
  - Core CPI surged to just over 3 percent in late 2002/early 2003, fell to 1½ percent in August, then edged up toward 2¼ percent by end 2003.
- Monetary policy response:
  - Bank of Canada eased policy in July and September 2003, and again in January 2004, returning overnight rates to 2½ percent.
- Fiscal position:
  - Federal surplus of C$7 billion (½ percent of GDP) in 2002/03; slowdown and budget initiatives likely to cause surplus to decline appreciably in 2003/04.
  - Public debt-to-GDP ratio expected to fall further; authorities committed to rebuilding normal budgetary reserves.
  - Provinces: a sizable deficit emerged reflecting pressures on health care and SARS/BSE costs; provinces delayed tax cuts and announced spending cuts.

### Executive Board Assessment (PIN summary)
- Directors commended:
  - Canada’s strong monetary and fiscal policy framework and structural reforms since the early 1990s.
  - Transparency of the Bank of Canada’s inflation targeting framework.
- Near-term outlook and policy stance:
  - Near-term macroeconomic outlook broadly favorable; growth likely to rebound next year, underpinned by household spending and business investment.
  - Downside risks: strength of the Canadian dollar could weigh on net exports and domestic profitability.
  - Given limited fiscal maneuver room, principal responsibility for cyclical recovery lies with monetary policy.
  - Directors welcomed the Bank of Canada’s decision to lower interest rates and noted there may be room to cut further if needed.
- Exchange rate and external position:
  - Directors welcomed exchange rate flexibility; while appreciation raised concern, they did not view the exchange rate as significantly out of line with fundamentals, considering Canada’s current account surplus and improved net foreign liability position.
- Fiscal framework and recommendations:
  - Commended fiscal framework for substantial debt reduction; noted need to sustain debt reduction given aging-related fiscal burdens.
  - Some Directors suggested complementing two-year budgetary planning with a clearer longer-term anchor and more cyclical flexibility; others found current framework adequate.
  - Suggested forthcoming budget demonstrate a firm commitment to rebuilding normal budgetary reserves.
  - Welcomed comprehensive expenditure review and shift toward expenditure control.
  - No need seen for broad-based tax cuts; scope exists to improve tax incentives for labor and capital market efficiency and competitiveness with the United States.
  - Encourage efforts to avoid excessive marginal effective tax rates from withdrawal of social benefits at low income levels.
- Health, pensions, and fiscal federalism:
  - Supported federal-provincial Health Accord but urged stronger incentives to contain health care costs and usage.
  - Urged simplifying and containing federal burden of the equalization payment system.
  - Noted public pension system generally sound but recommended further reforms (e.g., improving actuarial fairness of CPP benefit adjustments for early/late retirement; consider gradual rise in retirement age).
- Financial sector and regulatory policy:
  - Noted resilience of Canadian financial system and commended regulatory framework, corporate accounting, and governance efforts.
  - Favored harmonizing securities market regulation and legislation, including potential single regulator.
  - Suggested strengthening disclosure and rules governing contribution holidays for defined-benefit pension plans and harmonizing federal-provincial regulation and supervision.
  - Welcomed increased transparency on bank merger proposals.
- Employment insurance and productivity:
  - Observed cross-subsidization in employment insurance; suggested review consider experience-rated premiums and alternative funding options.
  - Noted slight widening of productivity gap with the United States; encouraged reforms to enhance efficiency, including reducing barriers to foreign direct investment and inter-provincial trade.
- Trade and development:
  - Favored easing import barriers, especially in agriculture, to encourage competitive efficiencies.
  - Encouraged Canada to play a leadership role in bridging differences in the Doha Round and to increase overseas development assistance.

### Key selected economic indicators (data as available at the time of the Executive Board Discussion on February 18, 2004)
- Real GDP (annual change, percent):
  - 1997: 4.2
  - 1998: 4.1
  - 1999: 5.5
  - 2000: 5.3
  - 2001: 1.9
  - 2002: 3.3
  - 2003 (est.): 1.6
- Net exports (contribution to growth, percent): -1.7; 1.7; 1.4; 0.6; 0.6; -0.3; -2.5
- Total domestic demand (annual change, percent): 5.7; 2.4; 4.1; 5.0; 1.7; 3.4; 4.4
- Private consumption (annual change, percent): 4.6; 2.8; 3.8; 4.0; 2.6; 3.4; 3.8
- Private fixed domestic investment (annual change, percent): 18.1; 2.8; 6.2; 5.8; 3.5; -0.2; 4.3
- Private investment rate (percent of GDP): 17.5; 17.7; 17.4; 17.0; 17.4; 17.0; 16.8
- Change in business inventories (contribution to growth, percent): 0.7; -0.3; 0.1; 0.8; -1.6; 1.8; 0.1
- GDP (current prices, annual change, percent): 5.5; 3.7; 7.4; 9.5; 3.0; 4.3; 5.2
- Unemployment rate (percent): 9.1; 8.3; 7.6; 6.8; 7.2; 7.7; 7.6
- Consumer price index (annual change, percent): 1.6; 1.0; 1.7; 2.7; 2.5; 2.3; 2.8
- GDP deflator (annual change, percent): 1.2; -0.5; 1.7; 4.0; 1.1; 0.9; 3.5
- U.S. cents/Canadian dollar (period average): 0.72; 0.67; 0.68; 0.67; 0.64; 0.64; 0.72
- Percent change (U.S. cents/Canadian dollar): -1.8; -6.8; 0.6; -0.3; -4.2; -1.1; 12.9
- Nominal effective exchange rate (percent change): 0.2; -6.0; -0.6; 1.2; -3.0; -1.8; 9.8
- Real effective exchange rate (percent change): 2.6; -6.3; -1.1; 0.0; -4.0; -0.4; 12.1
- Federal fiscal balance (percent of GDP): 0.7; 0.8; 0.9; 1.8; 1.2; 1.0; 0.6
- Provincial fiscal balance (includes local governments and hospitals, percent of GDP): -0.2; -0.6; 0.6; 0.8; -0.3; -0.9; -1.2
- General government (percent of GDP): 0.2; 0.1; 1.6; 3.0; 1.4; 0.8; 0.3
- Three-month treasury bill (percent): 3.2; 4.7; 4.7; 5.5; 3.9; 2.6; 2.9
- Ten-year government bond yield (percent): 6.1; 5.3; 5.6; 5.9; 5.5; 5.3; 4.8
- Current account balance (percent of GDP): -1.3; -1.2; 0.3; 2.9; 2.4; 2.0; 2.1
- Merchandise trade balance (percent of GDP): 2.9; 2.6; 4.3; 6.3; 6.4; 5.0; 5.0
- Export volume (annual change, percent): 8.5; 8.5; 11.7; 9.3; -3.5; 0.2; -2.4
- Import volume (annual change, percent): 16.5; 6.1; 8.5; 8.6; -5.6; 1.4; 3.3
- Invisibles balance (percent of GDP): -4.2; -3.8; -4.0; -3.5; -4.0; -3.0; -2.9
- Gross national saving (percent of GDP): 19.6; 19.1; 20.7; 23.8; 22.4; 21.9; 22.1
- Gross domestic investment (percent of GDP): 20.7; 20.5; 20.5; 20.4; 19.7; 19.9; 20.0

*Sources: Statistics Canada; and IMF staff estimates.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr0461.pdf_