## _cr0751 — Executive Summary and Selected Findings

## Source details

**Canonical URL:** [_cr0751 — Executive Summary and Selected Findings](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr0751.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr0751.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr0751.pdf.json)

---

### Background and Recent Performance
- The strong economic performance is likely to continue despite a recent slowing; Canada is particularly vulnerable to a sharper-than-expected U.S. slowdown.
- Large movements in commodity prices have exacerbated regional disparities, necessitating resource shifts across industries and regions, complicating monetary policy, and widening provincial differences in fiscal capacity.
- Over the last year, the Canadian economy has remained close to potential and inflation has been contained despite significant external shocks.
- A roughly 35 percent nominal effective appreciation of the exchange rate over the last few years offset the boost from rising commodity prices.
- Headline inflation has fallen below the 2 percent mid-point of the target range recently; core inflation has remained close to target.

### Macro Outlook, Risks, and Staff Projections
- Staff projects growth recovering to around potential of 2¾ percent by mid-2007 and inflation close to target (after adjusting for the recent GST cut).
- With the output gap around zero, inflation would remain close to the mid-point of the 1–3 percent band.
- U.S. spillovers tilt growth risks to the downside; various estimates suggest a percentage point fall in U.S. growth reduces Canadian activity by 0.3–0.7 percentage points (effect likely in the upper part of this range).
  - OLS regressions since 1995: Growth over last year 0.6; Growth over last quarter 0.4.
  - WEO forecast errors since 1995: Current year 0.6; A year ahead 0.7.
  - Macroeconomic models: IMF's Global Economic Model 0.3; Oxford Economics' Global Macroeconomic Model 0.3.
- Desk exchange rate equation and some staff multilateral analysis suggested the Canadian dollar could be modestly (0–10 percent) above equilibrium.
- Risk that the recent revival of labor productivity growth could be transitory; staff forecast assumes higher investment and greater competitive pressures will support productivity.

### Monetary Policy Assessment
- Monetary policy remains the first line of defense against macroeconomic shocks.
- The Bank of Canada has kept the policy rate on hold since May; after gradual tightening, the Bank has left rates at 4¼ percent since May.
- Current stance: maintain the policy rate at 4¼ percent (in line with market expectations), given symmetric inflation risks, real short-term interest rates around neutral, well-anchored inflation expectations, and moderate labor cost increases.
- The Bank lowered its estimate of potential output growth, partly recognizing the shift of resources from manufacturing to the commodity-rich west.
- The Bank’s renewal of the inflation targeting framework for a further five years was welcomed; Bank officials have greater flexibility to announce adjustments to the 6–8 quarter time frame for returning inflation to the target.
- Staff welcomed the Bank’s intention to continue to analyze the benefits and costs of a lower inflation target and price level targeting (PLT) in time for the next renewal.
- PLT summary: targets a path for the price level; contrasts with inflation targeting where high inflation now implies lower inflation later. Mixed conclusions exist about IT vs PLT; a “hybrid” strategy often works best. A “hybrid” regime could be introduced evolutionarily by adding a criterion that inflation should average the target rate over the medium term.

### Fiscal Policy Assessment and Recommendations
- Fiscal policy appropriately focused on further reducing debt, lowering taxes, and reforming federal-provincial transfers.
- November Fiscal Update showed FY2005–6 federal surplus of 1 percent of GDP, 0.4 percentage points higher than projected in the May Budget. Program expenses fell in nominal terms for the first time since FY1996–97.
- Staff view: reducing Canada’s high marginal effective income tax rates (particularly on investment) would provide greater efficiency benefits than a further cut to the Goods and Services Tax (GST).
- Fiscal prudence and debt strategy:
  - Continued targeting of debt reduction of C$3 billion.
  - Advancement of the commitment for lowering the federal debt ratio to 25 percent by a year to FY 2012–13.
  - Allocation of unanticipated surpluses to further lowering debt.
  - Goal to eliminate general government net debt by 2021, with asset accumulation by public pension plans and balanced provincial-territorial budgets cited as important.
  - Recommendation: regular assessment of long-term sustainability and steps to contain public health spending growth.
- Tax policy and interactions:
  - Officials intend to reduce the tax burden supported by steady reductions in spending as a ratio to GDP and to use savings from debt service to lower personal income taxes.
  - Suggested tax reforms: lower taxes on dividends and capital gains; raise contribution limits on tax-advantaged retirement plans; address differential tax treatment between large and small firms.
  - Promised further GST cuts could provide fiscal room for remaining provinces to harmonize their sales taxes with the GST; harmonization to a VAT would eliminate provincial taxes on business inputs, lowering marginal effective rates on investment.

### Equalization and Provincial Fiscal Capacity
- Reforms to federal equalization transfers should reduce differences in provincial fiscal capacities and be more rules-based and predictable.
- Staff support: O’Brien panel’s recommendations to partially include resource revenues from all provinces in the standard for equalization transfers and to cap transfers so no receiving province would have a higher fiscal capacity than a nonreceiving one.
- Federal officials: panel’s proposals provide a useful starting point for negotiations; general but not unanimous acceptance by provinces.

### Financial Sector Soundness and Structural Recommendations
- Financial sector is stable, well-capitalized, and well positioned to cope with a turning of the global credit cycle; bank profitability and capital were high by historical (and international for capital) standards.
- Risks from the housing market were relatively limited; U.S. exposures remain a traditional source of earnings volatility.
- Recommendations to improve efficiency and innovation:
  - Reduce regulatory impediments to bank entry and consolidation.
  - Establish a national securities regulator to harmonize securities regulation and reduce compliance costs.
  - Address funding challenges of defined benefit pension plans; early action and public consultation on reform welcomed.
- Directors recommended moving toward establishing a national securities regulator and looked forward to further analysis in the planned Financial Sector Assessment Program update.

### Structural Agenda to Boost Productivity (Advantage Canada)
- Objective: sustained productivity growth essential to raise living standards in the face of an aging population.
- Measures emphasized:
  - Make the tax system friendlier for saving and investment; Canada’s effective marginal tax rates on investment are among the highest in the world, partly reflecting provincial sales and capital taxes.
  - Phase out the tax advantage for income trusts while addressing other distortions, including different rates for large and small firms.
  - Regulatory reforms to encourage product market efficiency, including easing restrictions on foreign direct investment in network industries (airlines, communications, media) and addressing public ownership in the electricity sector.
  - Reduce interprovincial barriers to trade; note the Alberta-British Columbia Trade, Investment, and Labour Mobility Agreement as welcome but incomplete.
  - Improve employers’ access to skilled workers by adapting the immigration system to skill shortages and improving recognition of professional qualifications across provinces.
  - Address Employment Insurance system costs to labor market participation; consider funding social benefits of Employment Insurance through general revenues and curbing extended regional benefits.

### Selected Quantitative Projections and Key Statistics (as presented)
- Real GDP: 2005 2.9; 2006 2.8; staff projects recovery to around 2¾ percent by mid-2007.
- Net exports (contribution): 2005 -1.6; 2006 -1.3.
- Total domestic demand: 2005 4.8; 2006 4.1.
- Final domestic demand: 2005 4.3; 2006 4.2.
- Private consumption: 2005 3.9; 2006 3.8.
- Private fixed investment: 2005 7.1; 2006 6.0.
- Inventories (contribution): 2005 0.3; 2006 0.0.
- Unemployment rate (percent): 2005 6.8; 2006 6.3; 2007 quarterly values ~6.3–6.4.
- Consumer price index: 2005 2.2; 2006 2.1.
- Federal fiscal balance/GDP: 2005 0.1; 2006 0.4; 2007 0.3.
- Current account balance/GDP: 2005 2.3; 2006 1.8.
- Oil prices ($/Barrel): 53.4; 64.4; 63.3; 64.3; 61.0; 68.3; 69.0; 59.3; 61.8; 63.0; 64.0; 64.3 (historical and quarterly 2006–2007 values shown).
- Federal Budget: Staff Projections (In percent of GDP)
  - Revenue: 2003/04 16.4; 2004/05 16.4; 2005/06 16.2; 2006/07 15.9; 2007/08 15.8; 2008/09 15.5; 2009/10 15.3; 2010/11 15.1.
  - Outlays: 2003/04 15.6; 2004/05 16.3; 2005/06 15.2; 2006/07 15.5; 2007/08 15.5; 2008/09 15.5; 2009/10 15.2; 2010/11 14.9.
  - Budget balance: 2003/04 0.8; 2004/05 0.1; 2005/06 1.0; 2006/07 0.4; 2007/08 0.3; 2008/09 0.2; 2009/10 0.2; 2010/11 0.3.
  - Net debt: 2003/04 40.9; 2004/05 38.3; 2005/06 35.1; 2006/07 33.2; 2007/08 31.6; 2008/09 29.9; 2009/10 28.3; 2010/11 26.8.
- Selected fiscal and macro figures (from tables):
  - Real GDP growth (2006 estimate): 2¾ percent.
  - Private consumption growth (2006): 3¾ percent.
  - Business investment growth (2006): 8 percent.
  - Residential investment (2006 vs 2005): 2½ percent above 2005.
  - Current account surplus (2006): 1¾ percent of GDP.
  - Unemployment rate (2006): 6.1 percent.
  - Bank of Canada target rate: 4¼ percent.
  - Canadian dollar appreciation since late 2002: roughly 35 percent against the U.S. dollar.
  - Per capita real GDP, Canada: 2.3 (2005), 1.9 (2006), 1.8 (2007), 1.5 (Est.Proj. row context).
  - CPI inflation, Canada: 2.6 (2003), 1.8 (2004), 2.2 (2005), 2.1 (2006).
  - Federal government revenue (2005/06): 229.3 (billions of dollars).
  - Federal government program spending (2005/06): 188.6 (billions of dollars).
  - Budgetary balance (accruals basis) (2005/06): 6.1 (billions of dollars).
  - Net federal debt (2005/06): 478.5 (billions); net federal debt as percent of GDP: 33.2 (2005/06).
  - General government net debt (2005/06): 39.1 (percent of GDP).
  - Current account balance (in percent of GDP): 1.2 (2006 est.), projected 1.4 (2007 onward).
  - Merchandise trade balance (in percent of GDP): 4.6 (2006 est.), projected 3.5 (2007).
  - Exports, goods (billions of Canadian dollars): 476.6 (2006), projected 501.9 (2007), 525.4 (2008).
  - Imports, goods (billions of Canadian dollars): 425.7 (2006), projected 446.8 (2007), 469.2 (2008).
  - Three-month treasury bill (percent): 4.4 (2006 projected), 4.4 (2007), 4.4 (2008).
  - Ten-year government bond yield (percent): 4.3 (2006 projected), 4.6 (2007), 5.0–5.1 (2008–2011 range).

### IMF Executive Board Conclusions and Recommendations
- The IMF Executive Board concluded the Article IV consultation with Canada on January 12, 2007.
- Board commended Canada’s sound monetary and fiscal frameworks and recent macroeconomic performance.
- Main Board advice and Directors’ recommendations:
  - Monetary policy: current stance appropriate; continue inflation-targeting framework.
  - Fiscal policy: continue debt reduction; use interest savings to lower personal income taxes and reduce effective marginal tax rates on investment; contain public health costs for long-term sustainability.
  - Financial sector: reduce regulatory impediments to bank entry and consolidation; move toward a national securities regulator; further Financial Sector Assessment Program analysis.
  - Structural reforms: cut effective capital taxes (including through provincial actions), improve financial market competition, phase out FDI restrictions, eliminate interprovincial barriers to trade in goods and labor mobility, increase immigration system flexibility, and increase market access for agricultural goods.
- Recommendation: next consultation occur on the usual 12-month cycle.

*Source: Executive Summary and sections from _cr0751 (IMF staff report and IMF Executive Board conclusions).*

### Executive Summary ......................................................................................................

### _cr0751 - Executive Summary ......................................................................................................

### Background
- The strong economic performance is likely to continue despite a recent slowing, but risks are on the downside as Canada is particularly vulnerable to a sharper-than-expected U.S. slowdown.
- Large movements in commodity prices have exacerbated regional disparities, necessitating resource shifts across industries and regions, complicating monetary policy, and widening provincial differences in fiscal capacity.

### Key Policy Issues and Staff Conclusions
- Monetary policy
  - Monetary policy remains the first line of defense against macroeconomic shocks.
  - The Bank of Canada has kept the policy rate on hold since May and has adroitly balanced competing growth and inflation risks.
  - The current stance appears appropriate going forward, although much will depend on incoming data.
  - The renewal of the inflation targeting framework is welcome; the Bank intends to continue analysis of possible future improvements.
- Fiscal policy
  - Fiscal policy is appropriately focused on further reducing debt, lowering taxes, and reforming federal-provincial transfers.
  - Reducing effective marginal tax rates on investment would provide larger efficiency gains than further cuts to the Goods and Services Tax.
- Financial sector
  - The financial sector is stable and well-capitalized, well positioned to cope with a turning of the global credit cycle.
  - Scope exists to improve financial sector efficiency and innovation by reducing regulatory impediments to bank entry and consolidation and by establishing a national securities regulator.
- Structural agenda
  - Government focus on enhancing productivity is timely.
  - Additional reforms suggested: cut high marginal effective tax rates on investment; improve financial intermediation; phase out restrictions to foreign direct investment; increase immigration system flexibility; eliminate interprovincial barriers to trade in goods and labor mobility.

### I. Introduction — Recent Performance and Focus of Discussions
- Over the last year, the Canadian economy has remained close to potential and inflation has been contained despite significant external shocks.
- A roughly 35 percent nominal effective appreciation of the exchange rate over the last few years offset the boost from rising commodity prices.
- Headline inflation has fallen below the 2 percent mid-point of the target range recently; core inflation has remained close to target.
- Recent slowing partly reflects weaker U.S. activity.
- Consultation discussions focused on:
  - Vulnerabilities to U.S. spillovers.
  - The fiscal framework and federal equalization payments overhaul.
  - Business environment and productivity improvements outlined in Advantage Canada.

### II. Macroeconomic and Financial Risks — Outlook and Vulnerabilities
- Staff projections and central tendencies
  - Staff projects growth recovering to around potential of 2¾ percent by mid-2007 and inflation close to target (after adjusting for the recent GST cut).
  - With the output gap around zero, inflation would remain close to the mid-point of the 1–3 percent band.
- U.S. spillovers
  - Staff viewed spillovers from the United States as tilting growth risks to the downside; inflation risks were smaller and more balanced.
  - Various estimates suggested that a percentage point fall in U.S. growth reduced Canadian activity by 0.3–0.7 percentage points; effect likely in the upper part of this range.
  - OLS regressions since 1995: Growth over last year 0.6; Growth over last quarter 0.4.
  - WEO forecast errors since 1995: Current year 0.6; A year ahead 0.7.
  - Macroeconomic models: IMF's Global Economic Model 0.3; Oxford Economics' Global Macroeconomic Model 0.3.
- Exchange rate and commodity prices
  - Floating exchange rate acted as a useful shock absorber.
  - Desk exchange rate equation and some staff multilateral analysis suggested the Canadian dollar could be modestly (0–10 percent) above equilibrium.
  - Rapid appreciation since 2002 mainly reflected the world commodity boom.
  - Given capacity constraints in Alberta, further oil price increases could be modestly negative.
- Productivity risks
  - Risk that the recent revival of labor productivity growth could be transitory.
  - Staff forecast assumes higher investment and greater competitive pressures will support productivity, but less optimistic scenarios could be envisaged.
- Domestic demand and balance sheets
  - Households: Robust real income growth and rising household wealth ratios supported consumption, even with near-zero household saving; house prices less inflated than in other cyclically-advanced countries; a near-prime mortgage market was beginning to develop.
  - Corporates: Profit margins have risen and financing conditions were comfortable; favorable outlook for business investment, aided by exchange rate strength lowering prices of imported equipment.
- Financial sector soundness
  - Bank profitability and capital were high by historical (and international for capital) standards.
  - Risks from the housing market were relatively limited.
  - Financial sector appeared well positioned to cope with weaker U.S. activity, though U.S. exposures remain a traditional source of earnings volatility.

### III. Macroeconomic Policies — Monetary and Fiscal Stance
- Monetary policy
  - Monetary policy should remain the first line of defense in response to macroeconomic shocks.
  - The inflation targeting framework has provided scope for the Bank of Canada to provide countercyclical support.
  - After gradual tightening, the Bank has left rates at 4¼ percent since May.
  - Current stance: maintain the policy rate at 4¼ percent (in line with market expectations), given symmetric inflation risks, real short-term interest rates around neutral, well-anchored inflation expectations, and moderate labor cost increases.
  - Bank has lowered its estimate of potential output growth, partly recognizing the shift of resources from manufacturing to the commodity-rich west.
  - The Bank’s renewal of the inflation targeting framework for a further five years was welcomed; Bank officials have greater flexibility to announce adjustments to the 6–8 quarter time frame for returning inflation to the target.
  - Staff welcomed the Bank’s intention to continue to analyze the benefits and costs of a lower inflation target and price level targeting (PLT) in time for the next renewal.
- Price Level Targeting (Box summary)
  - PLT targets a path for the price level; contrasts with inflation targeting where high inflation now implies lower inflation later.
  - Mixed conclusions exist about IT vs PLT; a “hybrid” strategy often works best.
  - A “hybrid” regime could be introduced evolutionarily by adding a criterion that inflation should average the target rate over the medium term.
- Fiscal policy
  - November Fiscal Update showed FY2005–6 federal surplus of 1 percent of GDP, 0.4 percentage points higher than projected in the May Budget.
  - Program expenses fell in nominal terms for the first time since FY1996–97.
  - The Update projected somewhat higher future surpluses than in the Budget.
  - Provincial fiscal positions have improved, in some cases due to resource revenues.

### Selected Quantitative Projections and Fiscal Metrics (as presented)
- Economic projections (annualized percent change or levels where indicated)
  - Real GDP: 2005 2.9; 2006 2.8; 2007 projections quarterly shown in table with mid-2007 around 2¾ percent recovery.
  - Net exports (contribution): 2005 -1.6; 2006 -1.3; 2007 quarterly values shown.
  - Total domestic demand: 2005 4.8; 2006 4.1; 2007 quarterly values shown.
  - Final domestic demand: 2005 4.3; 2006 4.2; 2007 quarterly values shown.
  - Private consumption: 2005 3.9; 2006 3.8; 2007 quarterly values shown.
  - Private fixed investment: 2005 7.1; 2006 6.0; 2007 quarterly values shown.
  - Inventories (contribution): 2005 0.3; 2006 0.0; 2007 quarterly values shown.
  - Unemployment rate (percent): 2005 6.8; 2006 6.3; 2007 quarterly values ~6.3–6.4.
  - Consumer price index: 2005 2.2; 2006 2.1; 2007 quarterly values shown with overall near 2.0.
  - Federal fiscal balance/GDP: 2005 0.1; 2006 0.4; 2007 0.3.
  - Current account balance/GDP: 2005 2.3; 2006 1.8; 2007 quarterly values shown.
  - Partner country growth: 2005 3.3; 2006 3.5; 2007 quarterly values shown.
  - Oil prices ($/Barrel): historical and quarterly 2006–2007 values include 53.4; 64.4; 63.3; 64.3; 61.0; 68.3; 69.0; 59.3; 61.8; 63.0; 64.0; 64.3.
- Federal Budget: Staff Projections (In percent of GDP)
  - Revenue: 2003/04 16.4; 2004/05 16.4; 2005/06 16.2; 2006/07 15.9; 2007/08 15.8; 2008/09 15.5; 2009/10 15.3; 2010/11 15.1.
  - Outlays: 2003/04 15.6; 2004/05 16.3; 2005/06 15.2; 2006/07 15.5; 2007/08 15.5; 2008/09 15.5; 2009/10 15.2; 2010/11 14.9.
  - Budget balance: 2003/04 0.8; 2004/05 0.1; 2005/06 1.0; 2006/07 0.4; 2007/08 0.3; 2008/09 0.2; 2009/10 0.2; 2010/11 0.3.
  - Planned debt reduction: 2007/08 onward shows small planned reductions (......1.00.20.20.20.20.2 in table format).
  - Planning surplus: 2003/04 0.8; 2004/05 0.1; 2005/06 0.0; 2006/07 0.2; 2007/08 0.1; 2008/09 0.1; 2009/10 0.0; 2010/11 0.1.
  - Net lending and Net debt series presented in table (Net debt: 40.9; 38.3; 35.1; 33.2; 31.6; 29.9; 28.3; 26.8 for 2003/04–2010/11 respectively).
  - Note: Projections are based on the authorities' 2006 Economic and Fiscal Update adjusted for staff macro assumptions and include a GST cut of 1 percentage point in 2010/11.

### Structural and Other Policy Recommendations
- Financial sector
  - Reduce regulatory impediments to bank entry and consolidation.
  - Establish a national securities regulator to harmonize securities regulation and reduce compliance costs.
  - Address funding challenges of defined benefit pension plans; early action and public consultation on reform welcomed.
- Labor market and social policies
  - Reduce welfare walls, amend immigration systems to address skills shortages, and simplify recognition of occupational qualifications.
  - Consider funding social benefits of Employment Insurance through general revenues and curbing extended regional benefits (noting recent reforms improved EI funding).
- Trade and agriculture
  - Widen market access for agricultural goods, including those subject to “supply management” schemes, while Canada pursues an ambitious Doha outcome.

*Source: Executive Summary, _cr0751 (IMF staff report).*

### 13.      The team welcomed the Update’s focus on fiscal prudence (Figure 9). This included

### _cr0751 - 13.      The team welcomed the Update’s focus on fiscal prudence (Figure 9).

### Fiscal prudence and debt strategy
- Continued targeting of debt reduction of C$3 billion.
- Advancement of the commitment for lowering the federal debt ratio to 25 percent by a year to FY 2012–13.
- Allocation of unanticipated surpluses to further lowering debt.
- Goal to eliminate general government net debt by 2021, highlighting the role of:
  - Asset accumulation by public pension plans.
  - Balanced budgets by provincial-territorial governments (which deliver health services).
- Recommendation: regular assessment of long-term sustainability to buttress fiscal strategy.
- Rationale: Given spending pressures from population aging, fiscal sustainability requires a steady and significant decline in debt in coming decades, and further steps to contain public health spending growth.

### Tax policy, GST, and efficiency considerations
- Officials’ intention: reduce the tax burden supported by steady reductions in spending as a ratio to GDP.
- Commitment: use savings from debt service to lower personal income taxes to bolster social consensus for debt reduction.
- Staff view: reducing Canada’s high marginal effective income tax rates (particularly on investment) would provide greater efficiency benefits than the proposed further cut to the Goods and Services Tax (GST).
- Demographic consideration: With population aging steadily eroding the ratio of workers in the population, there is a case for bolstering consumption taxes.
- Policy interactions noted:
  - Promised further GST cuts could provide fiscal room for remaining provinces to harmonize their sales taxes with the GST.
  - Harmonization to a VAT would eliminate provincial taxes on business inputs, lowering marginal effective rates on investment.
  - A GST cut could help cushion the effect of higher sales taxes on consumption needed to offset revenue losses.
- Suggested tax reforms to support saving and investment:
  - Lower taxes on dividends and capital gains.
  - Raise contribution limits on tax-advantaged retirement plans.
  - Address differential tax treatment between large and small firms.

### Equalization transfers
- Agreement: reforms to federal equalization transfers should reduce differences in provincial fiscal capacities and be more rules-based and predictable.
- Context: Differences in provincial fiscal capacity had been widened by elevated commodity prices, prompting ad hoc bilateral arrangements.
- Staff support: O’Brien panel’s recommendations to partially include resource revenues from all provinces in the standard for equalization transfers and to cap transfers so no receiving province would have a higher fiscal capacity than a nonreceiving one.
- Federal officials: panel’s proposals provide a useful starting point for negotiations; general but not unanimous acceptance by provinces.

### Structural agenda to boost productivity (Advantage Canada)
- Objective: sustained productivity growth essential to raise living standards in the face of an aging population (Figure 10).
- Background issues: modest business investment ratios for machinery and equipment and R&D; widening productivity gap with the United States.
- Measures emphasized to enhance the business environment:
  - Make the tax system friendlier for saving and investment (Canada’s effective marginal tax rates on investment are among the highest in the world, partly reflecting provincial sales and capital taxes).
  - Phase out the tax advantage for income trusts while addressing other distortions, including different rates for large and small firms.
  - Regulatory reforms to encourage product market efficiency, including easing restrictions on foreign direct investment in network industries (airlines, communications, media) and addressing public ownership in the electricity sector.
  - Reduce interprovincial barriers to trade; note the Alberta-British Columbia Trade, Investment, and Labour Mobility Agreement as welcome but incomplete.
  - Lower regulatory impediments to bank entry and consolidation to increase efficiency and dynamism in the financial sector (Figure 11).
  - Improve employers’ access to skilled workers by adapting the immigration system to skill shortages and improving recognition of professional qualifications across provinces.
  - Address Employment Insurance system costs to labor market participation (evidence from comparisons between New Brunswick and Maine).
- Officials’ emphasis: Advantage Canada is comprehensive across all levels of government and includes priorities such as harmonizing sales taxes, eliminating capital taxes, reducing regulatory burden, creating a dynamic financial system, lower personal income taxes (including a Working Income Tax Benefit), immigration reform, improving post-secondary education, and encouraging interprovincial labor mobility.

### Staff appraisal and macro-financial assessment
- Growth and inflation outlook:
  - Staff projects growth will rebound to potential, estimated at around 2¾ percent, by mid-2007.
  - Inflation will stay around 2 percent.
  - Main risk: possibility of a larger-than-expected U.S. slowdown.
- Monetary policy: Bank of Canada has kept rates on hold since May; with policy rates in the neutral range and inflation pressures contained, the stance appears appropriate.
- Financial sector: well positioned to cope with a turning of the global credit cycle; banks are profitable, well-capitalized, and housing market risks are more limited than in other cyclically-advanced countries.
  - Scope exists to improve financial sector efficiency and innovation by reducing regulatory impediments to bank entry and consolidation and moving toward establishing a national securities regulator.
- Fiscal policy appraisal:
  - Appropriately focused on reducing debt, lowering taxes, and reforming the equalization system.
  - Long-term fiscal sustainability requires further debt reduction and steps to curb increases in public health spending.
  - Staff welcomes commitment to using interest savings from debt reduction to lower personal income taxes and to reducing effective marginal tax rates on investment, which would provide larger efficiency gains than further cuts to the GST.
  - O’Brien panel reforms would make the equalization system more rules-based and predictable.
- Overall recommendation: With sound frameworks delivering macroeconomic stability, enhance prosperity by cutting tax rates on capital (including through provincial actions), improving financial market competition, phasing out restrictions to foreign direct investment, increasing immigration system flexibility, and eliminating interprovincial barriers to trade in goods and labor mobility.

*Source: _cr0751 - 13.      The team welcomed the Update’s focus on fiscal prudence (Figure 9).*

### 24.      It is recommended that the next consultation occur on the usual 12-month cycle.

### _cr0751 - 24.      It is recommended that the next consultation occur on the usual 12-month cycle.

### Executive Summary
- On January 12, 2007, the IMF Executive Board concluded the Article IV consultation with Canada.
- 2006 real GDP growth is estimated to have eased to 2¾ percent.
- The Board commended Canada’s sound monetary and fiscal frameworks and recent macroeconomic performance.
- The next consultation is recommended on the usual 12-month cycle.

### Macroeconomic Performance and Risks
- Growth and labor market:
  - Real GDP growth for 2006 estimated at 2¾ percent.
  - Employment gains significant; unemployment rate fell to 6.1 percent, its lowest level in more than 30 years.
  - Domestic demand remained the main driver: private consumption expanded 3¾ percent; business investment grew 8 percent.
  - Residential investment finished 2006 only 2½ percent above its 2005 level.
- External sector:
  - A sharp decline in natural gas prices and a fall in real net exports reduced the 2006 current account surplus to 1¾ percent of GDP.
  - The Canadian dollar weakened somewhat in recent months but remained roughly 35 percent higher against the U.S. dollar than in late 2002.
- Risks:
  - Growth risks are tilted to the downside given the possibility of a larger-than-expected U.S. slowdown.
  - Regional disparities: output, wages, and prices (especially housing prices) grew much faster in resource-rich western provinces, particularly Alberta.

### Monetary Policy and Inflation
- Bank of Canada:
  - After seven ¼ percentage-point hikes through May 2006, the target rate was left unchanged at 4¼ percent.
  - The rate was judged consistent with achieving the 2 percent inflation target over the medium term.
  - The Bank paused earlier than many other central banks; the current stance appears appropriate moving forward.
  - The Bank renewed the inflation-targeting framework without change for a further five years.
- Inflation and wages:
  - Recent decline in energy prices helped lower headline inflation below 2 percent.
  - Wage pressures appear modest despite deceleration in productivity growth.
  - Core inflation has remained close to the Bank’s target range of 1-3 percent.

### Financial Sector Soundness and Developments
- Performance:
  - Financial sector performance remained strong in 2006 amid benign global market conditions.
  - Bank profitability and capital are high by historical and international standards.
  - Distance-to-default measures suggest overall financial sector strength.
  - Long-term interest rates remained low despite monetary tightening; spreads on private instruments remained low.
- Structural observations and recommendations:
  - Directors saw scope to improve financial sector efficiency and innovation by reducing regulatory impediments to bank entry and consolidation.
  - Moving toward establishing a national securities regulator was recommended.
  - Directors looked forward to further analysis in the planned Financial Sector Assessment Program update.
- Linkages to U.S. markets:
  - Canadian banks’ international business increasingly focused on the United States.
  - Equity positions in U.S. assets have sold off recently; stock prices of financial institutions in Canada and the U.S. remain highly correlated.
  - The share of U.S. claims in banks’ overall balance sheets has dropped in recent years.

### Fiscal Policy, Public Finances, and Sustainability
- Fiscal outcomes:
  - Federal government delivered a larger-than-anticipated surplus of 1 percent of GDP in FY2005/06; program spending fell in nominal terms for the first time since FY1996/97.
  - Higher-than-expected surpluses projected for the current fiscal year; government advanced target for lowering federal debt to GDP ratio to 25 percent by FY2012/13 (one year earlier than previously planned) while cutting the GST from 7 percent to 6 percent on July 1.
  - Provincial fiscal positions improved, in some cases due to resource revenues.
- Executive Directors’ views:
  - Fiscal policy appropriately focused on reducing debt, lowering taxes, and reforming the equalization system.
  - Long-term fiscal sustainability will require continued debt reduction and steps to contain public spending on health care.
  - Directors welcomed the government’s commitment to use interest savings from debt reduction to lower personal income taxes and to reduce effective marginal tax rates on investment.
  - Most Directors viewed reductions in effective marginal tax rates on investment as likely to provide larger efficiency gains than further cuts to the GST, although a few noted GST reduction could support harmonization of provincial sales taxes with the GST.
  - Reforms suggested by the O’Brien panel on equalization would make the system more rules-based and predictable.

### Structural Issues and Policy Recommendations
- Productivity and competitiveness:
  - Directors welcomed the government’s Advantage Canada plans emphasizing productivity growth and prosperity.
  - Recommended measures include:
    - Cutting effective tax rates on capital (with provincial action to help).
    - Improving financial market competition.
    - Phasing out restrictions on foreign direct investment, particularly in network industries and ownership in electricity generation.
    - Eliminating interprovincial barriers to trade in goods and to labor mobility.
    - Increasing flexibility of the immigration system.
    - Enhancing access to Canadian markets for agricultural goods.
- Infrastructure, R&D, and regulation:
  - Highlighted issues in limited investment in machinery and equipment, moderate productivity growth, high effective taxes on capital, anti-competitive regulations on FDI and professional services, and below-OECD-average R&D spending and infrastructure quality.

### Selected Key Statistics and Projections (preserved as reported)
- Macroeconomic indicators and projections (selected):
  - Real GDP growth (2006 estimate): 2¾ percent.
  - Private consumption growth (2006): 3¾ percent.
  - Business investment growth (2006): 8 percent.
  - Residential investment (2006 vs 2005): 2½ percent above 2005.
  - Current account surplus (2006): 1¾ percent of GDP.
  - Unemployment rate (2006): 6.1 percent.
  - Bank of Canada target rate: 4¼ percent.
  - Canadian dollar appreciation since late 2002: roughly 35 percent against the U.S. dollar.
- From Table 1 and projections (selected entries):
  - Per capita real GDP, Canada: 2.3 (2005), 1.9 (2006), 1.8 (2007), 1.5 (Est.Proj. row context).
  - Real GDP (Canada): 3.3 (2004), 2.9 (2005), 2.8 (2006), 2.5 (2007 projected).
  - CPI inflation, Canada: 2.6 (2003), 1.8 (2004), 2.2 (2005), 2.1 (2006).
  - General government financial balance, Canada: 0.4 (1999), 2.9 (2000), 0.7 (2001), -0.1 (2002), -0.4 (2003), 0.5 (2004), 1.4 (2005), 1.1 (2006).
  - Gross national saving, Canada: 21.3 (1999), 23.6 (2000), 22.2 (2001), 21.0 (2002), 21.2 (2003), 22.9 (2004), 23.8 (2005), 23.9 (2006).
- Fiscal tables (selected):
  - Federal government revenue (2005/06): 229.3 (billions of dollars).
  - Federal government program spending (2005/06): 188.6 (billions of dollars).
  - Budgetary balance (accruals basis) (2005/06): 6.1 (billions of dollars).
  - Net federal debt (2005/06): 478.5 (billions); net federal debt as percent of GDP: 33.2 (2005/06).
  - General government net debt (2005/06): 39.1 (percent of GDP).
- Financial sector metrics (selected):
  - Mortgage-backed securities in percent of residential mortgage credit: notable difference between Canada and United States (figures shown in figures).
  - Corporate profits and returns: profit margins high; debt-to-equity and assets-to-net-worth ratios shown in figures.
- Balance of payments and external projections (selected):
  - Current account balance (in percent of GDP): 1.2 (2006 est.), projected 1.4 (2007 onward).
  - Merchandise trade balance (in percent of GDP): 4.6 (2006 est.), projected 3.5 (2007).
  - Exports, goods (billions of Canadian dollars): 476.6 (2006), projected 501.9 (2007), 525.4 (2008).
  - Imports, goods (billions of Canadian dollars): 425.7 (2006), projected 446.8 (2007), 469.2 (2008).
- Selected monetary indicators (from staff projections):
  - Three-month treasury bill (percent): 4.4 (2006 projected), 4.4 (2007), 4.4 (2008).
  - Ten-year government bond yield (percent): 4.3 (2006 projected), 4.6 (2007), 5.0–5.1 (2008–2011 range in tables).

### IMF Executive Directors’ Policy Conclusions and Advice
- Monetary policy: current stance appropriate; inflation-targeting framework to be continued.
- Fiscal policy: continue debt reduction; use interest savings to lower personal income taxes and reduce effective marginal tax rates on investment; contain public health costs for long-term sustainability.
- Financial sector: reduce regulatory impediments to bank entry and consolidation; move toward a national securities regulator; further Financial Sector Assessment Program analysis.
- Structural reforms: cut effective capital taxes, improve competition in financial markets, phase out FDI restrictions, remove interprovincial barriers, increase immigration system flexibility, and increase market access for agricultural goods.

*Source: IMF Public Information Notice (PIN) No. 07/18 — IMF Executive Board conclusions on the 2007 Article IV Consultation with Canada (January 12, 2007) — content and tables as provided in the supplied document.*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr0751.pdf_