David Dodge, the former governor of the Bank of Canada, has called on world central banks to co-ordinate increases in interest rates, undertake more expansionary fiscal policies and roll back financial regulation in order to increase financial investments and consumption. Mr. Dodge believes that more reliance on government investment and less reliance on low interest rates will increase global economic growth.
In a related article by Bill Curry on December 1 — With Trump’s tax plan, Ottawa must act to prevent economic exodus: David Dodge — Mr. Dodge called for the Canadian government to reduce effective taxes in order to prevent highly skilled individuals in professions like law and medicine from migrating to the US due to the President-elect’s proposed tax cuts.
Appropriate Subject Area(s):
Key Questions to Explore:
- Who is David Dodge? What roles has he played in the Canadian economy?
- What solutions is he proposing to revive the global economy?
- How are his solutions different from the conventional wisdom in macroeconomics?
- What effects would Mr. Dodge’s proposal have on the economy?
- What is a small business deduction?
Small business deduction, tax bracket, quantitative easing, monetary policy, expansionary fiscal policy, stagnation, inflation
- Small business deduction: This is a special deduction available to Canadian Controlled Private Corporations (CCPC) on the first $500,000 in active business income earned in Canada. A CCPC is a private corporation controlled (i.e. more than 50% equity-owned) by a Canadian resident. CCPCs are taxed at lower rates than regular corporations: for CCPCs, the first $500,000 in taxable income is taxed at 10.5%; for other corporations, taxable income is taxed at 15%.
- Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.
- Monetary policy is the process by which the Bank of Canada controls the supply of money, by targeting an interest rate of 2% to ensure price stability and general trust in the currency.
- Expansionary fiscal policy is a form of fiscal policy that involves decreasing taxes, increasing government expenditures or both in order to fight recessionary pressures.
- Stagnation is a prolonged period of little or no growth in an economy. Economic growth of less than 2% to 3% annually is considered stagnation, and it is highlighted by periods of high unemployment and involuntary part-time employment.
- Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling. Central banks attempt to limit inflation in order to keep the economy running smoothly.
- A copy of both articles
- A transcript of David Dodge’s remarks, titled The Role of Macro-Economic Policies in an Era of Global Economic Stagnation
Introduction to lesson and task:
David Dodge believes that the global economy is currently stuck in a low-growth phase characterized by excess supply, low and/or falling inflation, a low natural rate of interest, low productivity growth, and current account imbalances.
In order to achieve higher growth, Mr. Dodge has called on world central banks to increase interest rates to levels that will improve prices and financial stability, without sacrificing growth and employment. He believes that a co-ordinated announcement of a fixed schedule of rate increases among world central banks will facilitate better functioning of financial markets and reduce uncertainty. In his view, for this move to be successful, governments must also be willing to increase government spending on infrastructure to provide fiscal stimulus.
Mr. Dodge’s proposal would be a departure from conventional monetary policy, which aims to achieve price stability. For example, the Bank of Canada aims to keep inflation low, stable and predictable at a rate of 2%. If inflation is high and/or rising, the bank will increase interest rates in an attempt to keep inflation low. On the other hand, if inflation is low (i.e. below 2%), the bank will typically reduce interest rate to increase inflation by encouraging consumption and investment. In accordance with this policy, the bank has kept interest rates low because inflation is currently 1.2%.
Fiscal policy functions in a similar manner: during periods of excess demand, tax revenues automatically rise and expenditures (e.g. transfer payments) automatically fall. During periods of excess supply, slower growth generates reduced tax revenues and increased transfer payments (especially employment insurance) resulting in a fiscal stimulus.
This paradigm was applied in a coordinated way in 2009 to successfully deal with the collapse in global demand. However, this paradigm has been unsuccessful in restoring growth to its previous long-run path, despite ultra-low interest rates.
Mr. Dodge urges a movement away from the “low for long” interest-rate policies of most of the world’s central banks because he believes that interest rates have become too low to stimulate changes in investment and consumption.
Mr. Dodge recommends that central banks around the world increase their interest rates in a steady, predictable way and that government spending should bear more responsibility for facilitating economic growth.
Note: Since Mr. Dodge’s remarks, the U.S. Federal Reserve has increased interest rates.
Mr. Dodge on Taxes
The new small-business deduction will prevent business owners from multiplying access to the small-business tax rate by using complex partnerships and corporate structures. As a result, their effective tax rate will increase.
Mr. Dodge believes that relatively higher effective tax rates could incentivize high earning Canadian professionals who drive the Canadian economy to migrate to the United States if Mr. Trump and the Republicans are able to reduce personal income taxes there.
Action (lesson plan and task):
Hand students a copy of both articles
- Ask your students to define monetary policy and give a broad description of how it works.
- Ask your students to define fiscal policy and give a broad description of how it impacts the economic cycles.
- Ask your students to explain why is sometimes difficult for governments to co-ordinate monetary policy and fiscal policy. (Hint: Because monetary policy is controlled by an independent Bank of Canada and fiscal policy is controlled by the ministry of finance.)
- Ask your students to explain how a higher interest rate will lead to price and financial stability, without sacrificing unemployment and growth. (Hint: Mr. Dodge believes that a well coordinated rise in interest rates and lighter financial regulations will facilitate better- functioning financial markets and reduce uncertainty. Mr. Dodge also believes that governments should increase spending on infrastructure.)
- Ask your students to explain how a rise in interest rates could adversely affect unemployment and growth.
- Ask your students to explain the shortfalls of current monetary and fiscal policies.
- Last month, the U.S. Federal Reserve increased its benchmark interest rate by 25 basis points (0.25%) from 0.5% to 0.75%. Ask your students to explain the effects this move might have on the Canadian economy.
- Ask your students to explain what a small business deduction is.
- Let your students know that some people have suggested that the small business deduction should be phased out, and merged with the corporate tax rate. Ask your students if they believe this is a viable solution. (Remind them to think of the impact this proposal will have on genuine small businesses like convenience stores.)
Consolidation of Learning:
- Ask students to research David Dodge’s career path.
- Randomly select students to describe positions Mr. Dodge has held with the Bank of Canada and Ministry of Finance with the rest of the class and the job responsibilities associated with those positions.
- Finally, ask students to do some research into Mr. Dodge’s educational background and link it to his career path.
- By the end of this lesson plan, students should have a better understanding of how fiscal and monetary policy works.
- Ask students to do some research on the small business deduction (eligibility, active business income limit, etc.) and present their findings to the rest of the class.