A policy agenda for every horizon

I think we've seen enough of retrospectives on the past year and decade; it's time to reflect upon the future. So here are some things that we're going to have to think about, organised by time horizon.

The short run (less than one year):

1. When should the Bank of Canada start increasing interest rates? The Bank has promised to hold interest rates at where they are until June, unless inflation starts to drift above the 2% target. That didn't seem likely a couple of months ago, but inflation has started to inch its way back up to 2% since then. At this point, I don't think the Bank should be looking for an excuse to 'pull a fast one', so unless core inflation goes above (say) 3%, the Bank should keep its promise. And unless we see a much sharper recovery than we've seen so far, it shouldn't be in a hurry to raise interest rates very far or very fast.
2. What do we do with the fiscal stimulus measures? At the federal level, the measures are explicitly temporary, so it's best to let them run out. But if we start seeing more and more people exhausting their benefits, the EI package passed last fall may have to be revisited, again on a temporary basis.

The medium run (1-5 years)

1. How do we deal with the various budget deficits? As the recession recedes, much of the problem will go away by itself, but not all of it. At both the federal and provincial levels, structural deficits have established themselves, so something will have to be done. The easiest and best solution is to increase the GST/HST/QST - but politicians have made this almost impossible. (Although I'm heartened by reports that the Québec government is making noises about the possibility of increasing the QST beyond the one-ppt increase promised in last year's budget.)
2. What sort of climate change policy will we have? The easiest and best solution would be a carbon tax - but once again, politicians have made this almost impossible.
3. What can be done about the concentration of income at the very top end of the income distribution? I don't know. My initial reaction was to endorse a surtax at the very top end of the income distribution as a sort of speed bump to slow a noxious trend, but after having thought the matter through (and having my musings confirmed by some partial anecdotal evidence), I'm unconvinced that the tax system is the appropriate remedy. The challenge here is more analytical than political: until we have a good idea of how this concentration has come about, we're not going to develop an effective policy to reverse it. Corporate governance issues leap to mind, but we shouldn't be optimistic about getting quick and simple answers. But while we're trying to figure that out, we can at least work on a system of progressive transfers.

The long run (5 years and out).

1. What do we do about the ever-increasing share of total income that is going to health care? I have little to offer here, aside from repeating Herbert Stein's warning that "if something cannot continue forever, it will stop". Some thought will have to be given to how health spending will stop growing faster than the economy.
   
2. What can we do to attenuate the effects of demographic change? As I noted here, demographic shifts are "going to stop adding 0.5% to growth rates, and start reducing them by 0.4%", and this process is going to start in about five years. I can't see much of anything that can be done here; immigration can only have a marginal effect.
3. How can we increase the skills of the people who are still working? Forget about reducing post-secondary tuition fees: that's just a quick way of giving free money to rich kids. The challenge is to get children who may never have considered PSE to think about higher education as a realistic and a rewarding choice. And then to make sure that there is financial support to make it happen.
4. How can we make sure that there is the capital investment available to make full use of the available skills? Make it more profitable for investors to transform their savings into Canadian productive capacity. We're pretty well advanced on part of this agenda: various levels of governments have been steadily reducing corporate income taxes over the past few years. But there's probably more we can do to improve the workings of capital markets.
5. What should we do about encouraging research and development in Canada? I'm sceptical about making increased R&D a goal in itself: the benefits from R&D activity are wildly uncertain, and there's little to assure us that they will accrue to Canadians. High levels of R&D aren't a bad thing, but they're probably best viewed as an indication of success in items 3) and 4) above.

(Feel free to suggest more questions in the comments.)

It would appear that we're not going to run out of blogging material anytime soon.

Comments

[Andrew F]

I think we'll also have to do something about pensions and infrastructure. These are two already monumental and rapidly growing challenges.

[Stephen Gordon]

I've been thinking about writing about pensions. Anyone got some pointers for places to start doing some research?

[Andrew F]

CD Howe has a collection of policy papers on pensions and pension reform (http://www.cdhowe.org/display.cfm?page=PensionPapers). It seems like Keith Ambachtsheer is the go-to guy in Canadian media for pension policy expertise. He also has, what seems to me, a very good proposal for a supplementary pension plan for Canadians (http://www.cdhowe.org/pdf/commentary_265.pdf).

[Angelo Melino]

I think that you've misunderstood/misstated the "conditional commitment" of the Bank of Canada. Allowing for some wiggle room, the Bank said that it won't raise interest rates before the end of June unless it has a compelling reason to believe that inflation will exceed its target before mid 2011. It's not clear what would serve as a compelling reason, but whatever it turned out to be, the Bank would have to feel comfortable enough with its forecast that it would be willing to go out and try to convince the public of its position. While realized core inflation above 3% would certainly qualify as "compelling" evidence, so would a much lower bar. However, I agree with your conclusion about what the Bank should and will do. So far, private sector forecasts don't see inflation being a problem for the Bank's conditional commitment. And we'll know more about what the Bank thinks in a couple of weeks when it issues its updated forecast along with the MPR.

[Patrick]

If inflation does go above 2% and things aren't looking to bubbly, does anyone think the BoC will find an excuse to drag their heels on tightening so we can do some catching-up on levels that are below where they otherwise would have been sans last year's blow-up?

[Mike Moffatt]

"If inflation does go above 2% and things aren't looking to bubbly, does anyone think the BoC will find an excuse to drag their heels on tightening so we can do some catching-up on levels that are below where they otherwise would have been sans last year's blow-up?"

Yep - the BoC will be concerned that if they raise rates, they'll boost the Canadian dollar. Though I think that's closer to 'very legitimate reason' than it is to 'excuse'.

[Andrew F]

Legitimate reason insofar as a rate increase causing currency appreciation would slow the economy, and might cause the BoC to miss their target to the downside. The Bank seems very focused on their mandate, and people seem to be suggesting that they will bend it in order to avoid as much pain as possible for Canadians. I'm not convinced.

[Mike Moffatt]

"Legitimate reason insofar as a rate increase causing currency appreciation would slow the economy, and might cause the BoC to miss their target to the downside. The Bank seems very focused on their mandate, and people seem to be suggesting that they will bend it in order to avoid as much pain as possible for Canadians. I'm not convinced."

I don't think they'll bend their mandate. That being said, if inflation is forecasted to be at 2.2% I don't think they'll be in a hurry to get it down to exactly 2%.

[Frances Woolley]

Steve, Interesting post.

Good for you for talking about corporate governance issues. So hard, and sometimes things designed to make things better make things worse, e.g. salary disclosure.

On pensions - I think we're going to look back on the time when pensioners were comfortably off with the same sort of puzzled nostalgia that we have for traditional nuclear families or high quality British manufacturing or cars with tail fins - "Wow, that was cool, how did it ever happen?" It's the last 20 years when married couples over 65 faced the lowest risk of poverty of any demographic that, historically, are the aberration. Remember how crowded and crummy high school was because we were right at the tail end of the boom? The nursing homes will be the same. (b.t.w., http://www.theonion.com/content/node/29261, one of my all time favourite Onion articles)

I'm not at all convinced that productivity will be increased by sending more people to university. If (and I'm still not convinced this will happen) we ever see a labour shortage a pretty easy way to deal with it is just to have people in school for much less time.

[Jim Sentance]

Long run - how about how we deal with the economic turmoil caused by runaway climate change given that we did nothing about it earlier?

[Stephen Gordon]

Heh. Anyone up for a rousing lecture on time consistency?

[Stephen Gordon]

Frances: That Onion piece - and especially the last sentence - is hilarious!

[Patrick]

Jim: I dunno about that ... About the only thing sustaining my optimism (if you can call it that) is the prospect bankers fleeing their Manhattan mansion flats to refugee camps in the Adirondacks. Though I'm wondering if it's entirely moral to inflict bankers on the deer and black bears.

[Patrick]

OT, but too good to resist ...

"Fox News hires Sarah Palin"

And no, it's not from the Onion. It's from the G&M.

[Just visiting from macleans]

Also too good to resist...

"I recognize that my fellow economists say the recession is over...but"

0:15 in clip

http://watch.bnn.ca/squeezeplay/january-2010/squeezeplay-january-11-2010/#clip254230

[Jim Sentance]

"my fellow economists..."

Now I just feel dirty.

[Robert]

If you do choose to write about pensions, one document that I suggest that you look at is the "Summary Report on Retirement Income Adequacy Research" that was posted on the Finance website on December 18th. It can be found at the following address: http://fin.gc.ca/activty/pubs/pension/riar-narr-eng.asp

Federal and provincial finance ministers requested the report, and its main conclusions are questionable. It would be interesting if you could comment on the methodolgy used in the study, if an alternative methodlogy would have been preferable, if there are obvious faults in the analysis, and if there are material unexamined issues in the report.

[Patrick]

Robert: "... its main conclusions are questionable"

Why do you say that?

[Robert]

A response to Patrick as to why I am uncomfortable with the main conclusions of the report referred to in the post from January 12th.

Repeating the link at which you can find the report: http://www.fin.gc.ca/activty/pubs/pension/pdf/riar-narr-BD-eng.pdf

The discussion of the conclusions begins on page 26 of the report, and the second paragraph in that section begins "The first conclusion from the research....". When I read that paragraph, I asked myself the following questions:

- Are the conclusions in that paragraph based on information regarding Canadians currently aged 65 and over? If much of the data relates to persons who are currently retired, then the analysis and conclusions are applicable to persons born from 1910-1945. I question whether it is prudent to presume that a 50-year old, or a 30-year old will be in a similar situation when they eventually retire. I expect that a lower proportion of current workers are members of defined benefit pension plans as the trend for employers to avoid DB plans has developed in the past twenty years. I question whether working Canadians who are responsible for determining the amount of income to set aside are saving enough, and whether they can manage their investment portfolios effectively. On the face of it, there are real differences between the retirement savings framework faced by the current generation of retirees, and the environment faced by those who are currently employed
- Although a discussion of policy alternatives was beyond the scope of the report, could a revamped retirement system such as that adopted in Norway be considered for the current generation of Canadian workers?

I am concerned that the data used relates to the current generation of retirees, and it paints a rosier picture than that which the current generation of Canadians workers will actually face during their retirement in 15 or 25 years. It will be too easy for the Finance Ministers to conclude that no changes to the Canadian framework are necessary, which ignores the potential difficulties which the current generation of workers may face in the longer term.

I would be very interested in hearing the comments of others who have read the report.