Recent Canadian Economic Policy: Some Alternatives

Recent Canadian Economic Policy: Some AlternativesAuthor(s): H. C. EastmanSource: The Canadian Journal of Economics and Political Science / Revue canadienned'Economique et de Science politique, Vol. 18, No. 2 (May, 1952), pp. 135-145Published by: Wiley on behalf of Canadian Economics AssociationStable URL: http://www.jstor.org/stable/138139 .

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RECENT CANADIAN ECONOMIC POLICY: SOME ALTERNATIVES

H. C. EASTMAN Duke University

UNTIL the Canadian dollar was raised to parity with the American dollar in

July, 1946, Canadian foreign exchange reserves had been maintained at a

satisfactory level by an inflow of capital which offset the substantial current account deficit with the United States. After the appreciation, which was undertaken to insulate the domestic price level from rising prices abroad, the

capital flow was reversed and the official liquid reserves diminished rapidly until the end of 1947. The weakness in Canada's balance of payments position was caused by the fact that her surplus on current account was smaller than the rate at which her foreign loans were drawn down. The governmental policies undertaken to correct the balance of payments disequilibrium combined with a high level of national income in the United States to decrease the deficit in the current account with the United States and to replenish the reserves in 1948 and 1949.

The rapid increase in the merchandise deficit with the United States, evident in the first six months of 1951, and the declining rate of capital import pointed to the possibility of a deterioration in Canada's foreign exchange position. It is thus opportune to examine the effect of the policies followed by the Canadian government in its attempt to deal with the balance of payments disequilibrium of 1947. An attempt is made in this paper to discover how much these policies, especially import controls, contributed to the solution of the

problem. The programme instituted in November, 1947 involved the placing of pro-

hibitions and quotas on imports of consumer goods and the licensing of imports of capital goods under the Emergency Exchange Conservation Act.1 The

import controls were designed to impede importation of American goods and, where possible, to stimulate imports from other sources.2 The programme also included the very sharp decrease in foreign lending from nearly $600 million in 1947 to $126 million in 1948. In order to increase her earnings of American dollars, Canada in 1948 removed from export control a number of commodities whose exportation to the United States had been prohibited.

The recovery of $496 million which took place in Canada's foreign exchange reserves during 1948 was not caused by inflows of capital, for these amounted to only $126 million and were exactly equal in amount to Canada's foreign loans that year. The accumulation was the result partly of the three steps mentioned above and partly of developments over which Canada had no control. In 1948, current account credits with the United States were above those of 1947 by $500 million. This must have been caused by a rising national income in the United States as well as by the removal of export embargoes

111-12 Geo. VI, c. 7. 2Imports of oil, coal, farm machinery, and several small items were uncontrolled. Their

value rose by $130 million in 1948.

135

Vol. XVIII, no. 2, May, 1952



The Canadian Journal of Economics and Political Science

SELECTED FACTORS AFFECTING THE SIZE OF CANADA'S OFFICIAL LIQUID RESERVES, 1946-1949 (MILLIONS OF DOLLARS)

1946 1947 1948 1949 19502

Current account deficit with United States

Net receipts of convertible exchange from overseas

Net current deficiency

Capital transactions with U.S. dollar area1

Net redemptions of Canadian securities

Sale of new Canadian issue to insurance companies

Net sales (-+) or net re-

purchases (-) of outstand- ing Canadian securities

Redemptions and sales of U.S. and foreign securities (net)

All other capital movements Gold subscription to Inter-

national Monetary Fund Balancing item - errors and

omissions

Net change in official liquid reserves Decrease (+) Increase (-)

-607 -1,135 -393 -589 -394

+237 + 638 +763 +674 +138

-3170 - 497 +370 4- 85 -256

-238 - 227 - 96 - 31 - 44

+150

-1-204

+ 64 + + 78 +

+ 12 -

251 743

13 - 9 58 + 87

+ 41

+ 39

+-363

+ 65 +567

74

8 -4

496 134 695

'Capital transactions in Canadian dollars with foreign countries belonging to the Special Arrangement Area in 1947, 1948, and 1949, and other known transactions with other countries in 1949, are excluded.

2Subject to revision. Source: Dominion Bureau of Statistics, The Canadian Balance of International Payments,

Preliminary Statement, 1949, p. 14. Dominion Bureau of Statistics, The Canadian Balance of International Payments, .1950, p. 18.

from certain Canadian exports. The removal of export controls allowed the 1949 value of previously restricted exports to exceed that of 1947 by more than $177 million. The introduction of off-shore purchases by the Economic

Co-operation Administration was responsible in part for the ease with which Canada was able to readjust. In 1948, authorized purchases by the Economic

Co-operation Administration in Canada totalled US $592 million. From the

inception of the programme to June, 1950, authorizations for purchases in Canada amounted to US $1,155 million. It must be borne in mind, however, that, had these expenditures not been made by the Economic Co-operation Administration, foreign purchasers would probably have made a major part of them with dollars found elsewhere. To a substantial extent, off-shore purchases in Canada contributed to the increase in British rather than in Cana- dian foreign exchange reserves.

Two other factors also made for an increase in exports to the United States. The first was the signing of the General Agreement on Tariffs and

136

M



Recent Canadian Economic Policy

Trade.3 The influence of the American reductions in permitting an increase in Canadian exports is difficult to measure with precision. However, some indication that the tariff decreases did have an effect may be found in the fact that between 1947 and 1949 Canadian exports to the United States, on which the duty had not been reduced, increased by 28 per cent whereas

exports of those commodities on which the duty had been decreased but which had not been under export control in 1947 increased by 38 per cent. The second factor tending to increase Canadian exports to the United States was the export bonus arrangement in the Emergency Exchange Conservation Act. This arrangement provided for additions to be made to the American dollar allotment received by a firm when its exports to scheduled countries exceeded those made in the base year. The bonus was equal to the dollar import content of such additional exports plus 50 per cent of the net gain of foreign exchange to Canada. Some, perhaps most, of the commodities involved in this new trade in manufactures to which the bonus applied were produced at higher cost in Canada than in the United States, the market to which they were being sent. At least part of that trade moved in a direction that it would not have taken in a free market. Many branch plants of American companies made arrangements with their parent companies either to sell them parts and

components or to obtain a share of parent companies' sales in foreign markets.

Despite the Minister of Finance's statement on the radio on November 17, 1947, that "what the Government has in mind in this whole programme is not the stimulation of uneconomic production but rather the encouragement of more rapid development of our resources and industry in an efficient manner," some of these intra-company arrangements were probably made at a cost that would not have been assumed had it not been for the inducement of the export bonus in highly valued, though not officially high-priced, American dollars and for the desire of branch plants to co-operate with the government.

In the debate in the House of Commons on the Emergency Exchange Con- servation Act on December 16, 1947, the Minister of Finance estimated that the import controls would save Canada $300 million per annum. In 1948, imports of controlled items from scheduled countries were $300 million less than in 1947. Rising prices in 1948 meant that the volume of imports was lower than in 1947 by $386 million at 1947 prices.4 Without control imports in 1948 would undoubtedly have exceeded those of 1947 so that it may be concluded that the controls saved somewhat more than $300 million in 1948.

The actual accumulation of foreign exchange reserves that took place in 1948 was $496 million or $196 million more than the minimum figure for dollar saving for which the controls are estimated to have been responsible. It appears that Canada would not have suffered from a further drain of exchange reserves in 1948, even had the import restrictions not been instituted,

3The Agreement was signed on October 30, 1947. The Agreement and its Schedules of Tariff Concessions were put into effect on January 1, 1948 by Australia, the Belgium- Netherlands-Luxembourg Customs Union, France, the United Kingdom, the United States and Canada.

41948 Schedule I and II import figures were deflated by the wholesale index. For Schedule III imports, estimate in the Report on the Administration of the Emergency Exchange Conservation Act, Schedule III, Dec. 31, 1948 to June 30, 1949 (Dept. of Trade and Commerce) was used.

137



138 The Canadian Journal of Ecownmics and Political Science

as long as other aspects of Canadian commercial policy had been the same in both instances. The cessation of foreign lending plus the removal of export controls, which had been adopted to favour the United Kingdom and keep down the Canadian price level, along with such minor aspects of the Canadian programme as travel restrictions and the gold mining subsidies would have been sufficient to stop Canada's loss of exchange reserves.

Not only was it imperative to halt the drain of foreign exchange, it was also plainly necessary to adopt a policy which would stimulate the accumulation of reserves. An adequate buffer was needed against possible future

developments which might cause a renewed drain. The burden of the import restrictions in terms of high prices, inequity, and expense of administration was the cost of the comfort of accumulating reserves at a rapid rate. However, the Government of Canada could have had resort to techniques designed to increase the surplus in the balance of payments on current account which would have been less costly than import controls and which would have had the same result.5

The merits of an anti-inflationary policy, as a means of increasing Canada's

foreign exchange reserves without distorting the pattern of trade by controls, have not been given attention, presumably because of the popular belief that Canada was actually following an anti-inflationary policy during the post- war years. This belief was based on the fact that the government had an over- all surplus of $963 million in 1947 and of $205 million in 1948. The fact was overlooked that an expansion in non-government loans and investments on the part of the chartered banks of $777 million in 1947 and $257 million in 1948 was allowed to take place, thus offsetting almost entirely the effect of a sensible budgetary policy. The expansion of bank credit occurred in two ways. First, instead of keeping the government surplus in inactive deposits, bank debt was repaid, thereby creating excess reserves. Second, instead of the amount of reserves possessed by the chartered banks being substantially decreased, they were decreased by only $22.3 million in 1947, at a time when the cash ratio of banks declined from 11.4 per cent to 10.8 per cent. The reserves increased by $18 million in 1948 when the average cash ratio was 10.9 per cent. Reinforcing the inflationary effects of the expansion of non-

government loans and investments by the banking system was a substantial sale of government bonds by the public to the banks. The amount of liquid assets including bank deposits and government bonds in public hands decreased by $143 million in 1947 and increased by $115 million in 1948 but there was a decrease of bond holdings of $378 million in 1947 and of $541 million in 1948. The rate of interest on the longest term Victory Loan Bonds

(maturing 1966) was steady at 2.60 per cent in 1947 and 2.98 per cent through most of 1948. The Bank of Canada evidently put no pressure on the chartered banks to contract credit and may have deliberately supported the price of bonds from time to time thereby increasing the amount of legal reserves.

In 1948 the price level in Canada rose because of the controls and because the Bank of Canada did not restrict the volume of credit extended by the

aImport controls were costly in two ways. First, resources were consumed in the administration of the controls. Second, the controls removed some of the consumer's freedom of choice and decreased his welfare by making him take what he wanted less in place of what he wanted more.




chartered banks. The prices of imported commodities rose to a level higher than American prices plus the tariff. The price of import-competing commodities rose to equality with import prices. The price of domestic commodities rose because of the income inflation whereas the price of exports rose only to an extent equal to inflation abroad.

The effect of the actual policy was to stimulate investment and curtail consumption in a period when investment was already an extraordinarily high proportion of the gross national product (22 per cent in 1947).6 Investment increased because of the attractiveness of domestic and import-competing industries and because there was no shortage of loanable funds. Investment also expanded because import restrictions discriminated in favour of investment goods and against consumption goods. Schedule I and II imports fell by 47 per cent in physical terms whereas Schedule III imports fell by only 17 per cent between 1947 and 1948.7 The 1948 physical volume of investment other than inventory investment was 8 per cent above 1947, personal consumption was 1 per cent below 1947 and investment in inventories was 37 per cent below 1947. Investment was attracted by high returns to industries producing for the domestic market rather than to export industries.8 The more rapid increase in domestic than in foreign prices tended to decrease the volume of exports rather than increase it. The fact that the physical volume of exports remained constant and did not decrease in 1948 may be attributed to ex- panding income in the United States, to special incentives to export, to public spirit, to the effect of exhortation, and, perhaps, to the slowness of adjustment in the pattern of production. In 1949, total exports declined by 3 per cent. Exports to the United States also fell by 3 per cent.

Had an actual anti-inflationary policy been followed, it would have caused an adjustment in the balance of payments without the need of administrative decisions and direction, and it would have automatically directed investment to its most appropriate place. An attempt is made below to trace the sequence of events that would have taken place had Canada pursued an anti-inflationary policy, that is, a policy designed to keep money incomes stable.

If the Bank of Canada had acted so as to maintain a stable level of income in Canada, rising prices in the United States would have raised the prices of imports, of import-competing goods, and of exports. These rises would attract resources from the production of domestic goods to export and import-competing industries. The output of domestic goods would fall as a consequence of the loss of factors of production. It is impossible to tell a priori with abso- lute certitude whether the prices of domestic goods would fall or rise. The result would depend upon whether the decline in production of domestic

6This figure includes Investment in Inventories. Other Gross Private Capital Investment was 15 per cent of the Gross National Product. Gross Home Investment was 3 per cent of Gross National Product in 1933 and 16 per cent in 1939.

?Schedule I contained consumption goods whose importation was banned, Schedule II contained consumption goods under quota and Schedule III contained capital goods and parts.

sThe disappearance of a number of firms (e.g. refrigerator manufacturers) upon the removal of the controls is evidence that some firms existed solely because of the controls. At least forty-two of the manufacturing firms employing ten or more people, which com- menced operations in Canada in 1948, 1949, and 1950, were established because of the import controls or with the aid of the Import Control Division.

139




goods was greater or smaller than the decline in the proportion of income

spent on them. There are grounds for supposing that the prices of domestic

goods would rise, however, for the elasticity of demand for export goods, import goods, and import-competing goods together probably is not far from

unity, whereas a substantial shift in resources to export industries and to

import-competing industries where Canadian production was displacing im-

ports would undoubtedly take place. There would thus be a decline in supply of domestic goods but not in effective demand. In any case, there would be a rise in the general price level despite fixed incomes, for the export surplus would increase as foreign prices rose, leaving fewer goods and services to be

purchased with the fixed incomes. New investment would flow to the profitable industries which produced

for export and in competition with imported goods. The volume of investment would be less, however, under this arrangement than it was under import control, which, together with inflation, compelled consumers to curtail con-

sumption. The source of investible funds would be limited to current savings. It could not be expected that savers could be induced to decrease the volume of their consumption by an increase in the rate of interest. There could be no

expansion of bank credit under the condition of stable income nor could firms that wished to invest cause a net sale of accumulated securities for

society, for the banks could not buy them if the Bank of Canada would not

expand their reserves. The only possibility of an excess of loanable funds over current savings would be that an investor with cash had been waiting to

buy securities and used the cash to buy them at this time. This net increase in demand for goods and services would have to be offset by the central bank.

An anti-inflationary policy would cause a decrease in real expenditure on both consumption and investment and hence would stimulate exports and decrease imports. In contrast, import controls decreased consumption imports rather than investment goods imports and did not stimulate exports. The more elastic the Canadian demand for imports and the Canadian supply of exports, the greater would the adjustment be within a given period. After the export surplus had been developed to the point where the accumulation of reserves was deemed satisfactory for safety, the Canadian exchange rate could be allowed to rise pari passu with inflation abroad, thus offsetting the inflationary effect on domestic prices. The frequent claim that 'Canadian inflation was "caused by" the rise in import prices was valid only because Canadian monetary policy was too expansionary to permit appreciation of the exchanges when foreign prices rose. It is only if the exchange rate is unaltered that a rise in foreign prices must be translated into a rise in domestic prices.

A policy of keeping income stable would not have permitted prices to rise as far as they actually did. In 1948, the prices of imports from the United States and of import-competing goods were higher than the prices of comparable commodities in the United States (plus the tariff). Had an anti-inflationary programme been enforced, import prices would have been equal to United States prices (plus the tariff). From a welfare point of view, it is interesting to note that the prices of certain "necessities" would not have increased greatly under the suggested programme. Rents would not rise with American inflation. Prices of foods such as flour, potatoes, eggs, and dairy products are determined

140




primarily or entirely by forces outside the United States. In so far as the prices of these "necessities" increased, however, this would increase the rapidity of the adjustment of the foreign exchange situation. The elasticity of demand for these goods being low, a rise in price would reduce consumer expenditures on other commodities and release them for export. It would also decrease the demand for imports thereby helping to develop a surplus in the balance of

payments. Had such a policy of stabilizing incomes been seriously undertaken when it

became evident that Canada was losing exchange reserves at too high a rate at the beginning of 1947, and had this been followed by the cessation of foreign lending and the removal of export control, Canada would probably not have been subjected to an exchange crisis. Moreover the institution of such a programme should not have been politically impossible for it did not involve income or price deflation, which would bring general unemployment. Had some chronic unemployment appeared despite the vigorous stimulus foreign inflation was giving to Canada's export industries, monetary restrictions could have been relaxed in order to secure the price rises necessary to absorb the

unemployed in new jobs.9 The traditional fear that a deflationary policy either is ineffective or goes too far had no basis in this case for all that was needed to avoid import controls was to resist inflationary forces sufficiently to maintain the Canadian price level below the rising American price level. In 1947 as in 1951, it was necessary only to prevent Canada from spending beyond her means, not to force contraction below full employment. There would inevitably be some frictional unemployment while factors were trans- ferred from domestic industries to export and import-competing industries. But the experience of labour transference during post-war reconversion indicates that the seriousness of frictional unemployment can easily be over- stated.

Substantial political benefits would arise from an anti-inflationary policy. The relatively high price level in the United States would be of benefit to the

large, powerful export industries. Perhaps most favourably affected amongst these would be the tourist trade, the largest Canadian export industry, which is exceptionally sensitive to differences in price levels. Furthermore, success in keeping Canadian prices below American prices would be very popular as attested by the self-congratulation which accompanied the greater comparative effectiveness of Canadian price control in the immediate post- war period.

The lag in Canadian prices caused by the anti-inflationary policy would have had the effect of stimulating exports to non-scheduled countries. How- ever the import markets of these countries were not in equilibrium anyway and were regulated by import controls so that the immediate consequence of the Canadian action would not have been serious; a lack of inflation in Canada might, at most, have increased the pressure on their controls. This would unfortunately have made more difficult the eventual return of overseas countries to a free market in Canadian dollars. The decline in Canada's

9The cost of living index rose by only 1 per cent during 1949 and yet full employment was maintained. Thus it cannot be claimed that rises of 10 per cent per annum and more were required to maintain full employment since 1946.

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demand for imports would have had a similar effect of increasing their balance of payments disequilibrium; but it cannot be argued that Canada should not have followed a desirable credit policy because the balance of payment position of other countries benefited from her excessive inflation. If it was desired to compensate overseas countries for Canada's failure to inflate, Canada could have made up the decrease in their dollar earnings by extending loans. In

any case, there is evidence that Canada was not solely, or even primarily, concerned with the welfare of foreign economies, for she reduced very sub-

stantially the rate at which her foreign loans could be drawn upon when she was herself confronted by a "dollar shortage." The claim that Canada's exchange difficulties were caused because the foreign loans were used up more

rapidly than had been expected and that she was entitled to curtail them for this reason cannot be supported in view of the statement of the Minister of Finance in the course of the debate on the British loan on April 11, 1946 that "... I would expect this credit that we are proposing to make available to Britain will be fully drawn upon by the end of 1948."10 There was no question but that the loans under Part II of the Export Credits Insurance Act would be fully drawn upon by the end of 1948.

The proposal that Canada should have devalued her exchanges in 1947 was

extensively discussed as an alternative to the import control programme as a means of combating Canada's losses of foreign exchange.1l Devaluation would not have taken place if Canada had followed an anti-inflationary policy; it was an alternative to that policy too. Devaluation had the disadvantage that it might have temporarily raised prices even above the height reached under import controls before it curbed American imports to the same extent as the controls. This would have been true because the prices of non-scheduled countries' exports would have risen as well as those from scheduled countries, a thing they did not do with the controls. Devaluation would have been superior to the controls in terms of allocation and consumer's welfare, however, for there would have been no interference with individual choice. Furthermore, the export industries would have been stimulated by rising prices to increase production with the otherwise more profitable import-competing industries.

Canada's international position would have been set right in 1947 had she established a free market in foreign exchange. With such a market the price of the American dollar would have risen to the point'where the quantity demanded and the quantity supplied on both trade and capital account were

equal. The price of the pound would probably not have fallen because of the restrictions of the British foreign exchange control authorities on the use of pounds. Exports to the United States would have increased and imports decreased while imports from non-dollar areas would have increased as much as they did under import control. The bilateral disequilibrium in Canada's

IoCanada, House of Commons Debates, 1946, I, 766. 1See Canada, House of Commons Debates, 1948, I, 323-73; W. T. G. Hackett, "The

Bank, the Fund, and the Canadian Dollar," D. C. MacGregor, "Dependence on Imports from the United States" and Courtland Elliott, "The Role of Capital Imports," in Canada's Economy in a Changing World, ed. J. Douglas Gibson. A. F. W. Plumptre, What Shall We Do with Our Dollar? (C.I.I.A. Special Series, Toronto, 1948). A. G. Walwyn, "A Realistic Dollar vs. Overvaluation and Controls," International Journal, III, spring. 1948.

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balance of payments would have disappeared. The essential advantage of a free market at that time would have been that it established internal relative values for foreign currencies which approximated their equilibrium relationship better than did official rates. This is what happened in France during the

experiment of 1948 when the cross-rate on the pound was $2.84. A rise in the value of the American dollar relative to the Canadian dollar and to soft currencies in Canada would have rendered unnecessary the burden of import control; it would have allowed individuals to make their own choices and would have increased the volume of international trade by stimulating exports to the United States and, therefore, imports from her. Cross-rates would have had the disadvantage of encouraging commodity arbitrage by stimulating imports from soft currency countries for re-export to the United States causing an accumulation of American dollars in Canada and of Canadian dollars in soft currency countries. However, re-exportation would not have been as serious a problem as it had been in the case of France, for Canadian dollars were as scarce at the margin in non-dollar countries as were American dollars. If they had not been, foreign export control could have been used to restrict exports to Canada of goods which could be sold in the United States. The establishment of a free foreign exchange market in Canada was not a feasible alternative to import control, however, given the opposition of the Inter- national Monetary Fund to uneven cross-rates of exchange. The Fund's hostility would have been difficult to disregard as it reflected official opinion in both the United States and the United Kingdom.

Import control, which was actually used in 1947, was announced as a temporary policy to be discarded when the strain on the balance of payments had disappeared. It was successful in that it did help the accumulation of foreign exchange; and, as it turned out, it became possible to begin relaxing the controls at the end of 1948 and to remove them completely by the end of 1950. That the policy Canada followed achieved its objective of reversing the loss of foreign exchange is not, however, a justification of it because other policies would have had the same effect under world conditions as they were and would have done this with less distortion and at less cost. The rigorous controls on imports actually imposed might, however, be justified on the grounds that there was no way of predicting that the problem would be so easy to solve since the solution was largely the result of the unforeseeable boom and armaments expenditures in the United States and of the Economic Co-operation Administration purchases. If there was danger that the problem really was of greater magnitude, might it not have been wiser to depend upon direct controls rather than on the indirect techniques such as deflation or depreciation, the quantitative results of which were more difficult to foresee?

Two comments may be made about this view. In the first place, the import controls which saved between $300 million and $400 million in 1948, an amount far too small to accomplish the entire adjustment of itself, were by no means painless. They fell more heavily upon some individuals than upon others, but all individuals were inconvenienced by them and if it had been necessary to curtail imports even more, the controls would have become a serious burden for Canadians. Secondly, had conditions not improved abroad, the progressive intensification of the controls necessary to protect Canada's

143




reserves would have distorted the pattern of production. Import control made for high Canadian prices for commodities imported from the United States and a monopoly profit for the importers. The danger was that these high prices for imported materials would create high cost industries in Canada.

High import and domestic prices would cause inefficient production as com-

pared to industries abroad and, if the controls were continued long, as they would have been with deteriorating conditions abroad, the high-cost domestic industries would become entrenched. It would become increasingly hard ever to return to an import market unhindered by physical controls. Canada would, to a substantial degree, lose the advantages of multilateral trade and could

only regain them at the cost of price decreases, with their attending difficulties, and of a widespread reorganization of production.

Under these conditions, the advantages of an anti-inflationary programme in Canada are clear. Canadian prices would not have been allowed to rise to a point from which they would have had to retire with great difficulty or be permanently maintained by controls. Had it been necessary to take further action to affect the balance of payments in a subsequent period, Canada would have been in a better position to do this with a low rather than a high price level and with an undistorted pattern of production.

Though more painful than an anti-inflationary policy, the course Canada chose did not bring upon her the dire results described above. She was happily able to remove her controls thanks to rising prices and prosperity abroad. Hence, by good fortune, the results of the policy were those antici- pated in the optimistic view of her leaders. But the fact that the experiment ended well is no justification for having undertaken it. Policy makers should not seek to make good guesses unless guessing is needed to maintain conditions in which individuals can guess for themselves.

The action taken following the excursion into controls has been a good deal more satisfactory. Once the United Kingdom and other countries had devalued their currency, the problem of the appropriate exchange rate policy for Canada was simplified. The remarkable reorientation12 of Canadian trade that took place in 1950 can be attributed to the devaluation of the Canadian dollar and to the closing of a part of overseas markets to Canadian products by foreign exchange controls. The vast inflow of speculative capital stimulated by rumours of appreciation in 1950 was halted by the establishment of a fluctuating rate of exchange in September. These developments satisfactorily settled the problem of foreign exchange reserves and the appropriate rate of exchange.

The price level, which had been rising only moderately since the end of 1948, began to rise rapidly after the outbreak of the war in Korea. Expansion in demand caused an over-all deficit to appear in the Canadian balance of payments on current account in the first half of 1951. The developing deficit and the declining rate of capital inflow threatened to cause a depreciation of the exchange rate or an outflow of foreign exchange if depreciation was to be resisted. Thus the long-term stability of Canada's international economic

12Canadian trade with the United States was the following percentage of total Canadian trade:

1989 1946 1947 1948 1949 1950 Exports 38 40 39 50 49 65 Imports 66 76 77 69 71 67

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position depended upon the solution of the fundamental problem of domestic inflation.

This new disturbance in Canada's economic position was resisted by more orthodox measures than those used in 1947. These included increased taxes, selective credit restrictions, a small rise in the rediscount rate of the Bank of Canada and a request by the Bank of Canada to the chartered banks that they should not further expand the volume of credit. The measures to restrict the

expansion of credit were mild and came late. Their effect on the price level is

scarcely yet13 discernible, but they have apparently affected the balance of

payments.14 The prospects are good that credit restrictions, combined with the sensible budgetary policy of Canada since the war, will curb inflation and

prevent another weakening of the international position. Unlike price and

import controls, this programme will not impair the efficiency of production by causing bottlenecks nor reduce consumer satisfaction by restricting freedom of choice.

13February, 1952. .4The Cost of Living Index rose rapidly during the first half of 1951 but has been steady

since August. The Wholesale Prices Index has shown a very slight decline since July. Canada's deficit on merchandise trade with foreign countries, quite large during the first half of 1951, was converted into a surplus after the month of August. The merchandise deficit with the United States declined steadily from a peak of $90 million in April, 1951 to only $14 million in December because of a fall in imports.

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Documents

Recent Canadian Economic Policy: Some Alternatives