What the government can do to reduce the gas price?

Essay by jayanithaHigh School, 12th gradeA+, October 2005

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A carefully considered economic policy of a government may in fact shield, to a certain extent, the Canadian economy from the shocks of increasing world prices of oil and resources. There are a number of policies that could be applied to achieve a stable domestic economy. Some of these points are discussed below.

1. Government Fiscal and Monetary Policies.

Governments in market economies play critical roles in providing the economic conditions in which the marketplace of private enterprise can function most effectively.

One such role is to provide a widely accepted, stable currency that eliminates the need for cumbersome and inefficient systems of barter, and to maintain the value of that currency through policies that limit inflation (an increase in the overall level of prices of goods and services).

Historically, market economies have been periodically afflicted by periods of rapidly rising price levels, at other times with high levels of unemployment, or occasionally by periods with both high rates of inflation and unemployment such as the German hyperinflation of the 1920s and the worldwide unemployment of the 1930s known simply as the Great Depression.

Only in this century have economists and government policymakers developed a standard set of stabilization policies - known as fiscal and monetary policies - that Canadian national governments can use to try to moderate (or ideally to eliminate) such episodes.

Fiscal policies employ government spending and tax programs to stimulate the national economy or to slow it down in times of high inflation (i.e. price rises) and low unemployment that Canada is experiencing at present.

To slow down an overheated Canadian economy - one where virtually everyone is working who wants a job, but where spending and prices are rising rapidly - the government has several options to keep prices from spiralling too high.

- It can cut its own spending;

- Raise taxes; or

- both, in order to lower aggregate spending and production levels.

Monetary policy involves changes in the supply of money and the availability of credit. In a period of high inflation and low unemployment, Canadian policymakers can cool down the economy by raising interest rates, thereby reducing the supply of money and the availability of credit. Then, with less money in the economy to spend and higher interest rates, both spending and prices will tend to fall, or at least increase less quickly. As a result, both output and employment will tend to contract.

The problem with the current situation is that, although Canada's economy is growing, the increases in world prices can lead to a slowdown as the businesses come to terms with increased cost of production. Knowing the current economic health and applying a suitable monetary policy is difficult.

When both unemployment and inflation rise at the same time, however, governments can face a dilemma. The reason is that monetary and fiscal policies are designed to adjust the level of total spending in a nation, but not to cope with a relatively sudden decline in supplies, which can trigger inflation and unemployment simultaneously. The current situation we Canadians find ourselves in had in fact occurred in past. One case occurred in the 1970s when embargoes on oil exports by major oil-producing nations caused huge price rises that rippled through the economies of the industrialized nations. Such decreases in supply raise price levels while lowering production and employment levels.

To deal with such supply shocks to Canadian national economy, our government can try to increase people's incentives:

- to produce;

- save; and

- invest.

Thereby increasing the effective level of competition in the nation by reducing monopoly power; or eliminate bottlenecks of key resources, whether a commodity such as oil or certain kinds of skilled labor like engineers.

In the case of oil-export restrictions, for example, Canada can stimulate domestic oil production, provide incentives for greater energy efficiency and conservation, and invest in alternative energy sources. However, most of these so-called supply-side policies tend to work slowly, over periods of years rather than months.

While governments can offer no panaceas in the long-standing fight against inflation and unemployment in market economies, they can be effective in moderating the effects of these problems.

Policy makers and economists now acknowledge an important government role in fighting unemployment and inflation with long-term stabilization policies, including generally stable rates of growth in the money supply, government spending programs that automatically rise when the economy slows down and fall when the economy picks up (such as benefits paid to unemployed workers), and tax schedules that reinforce those automatic spending programs by taking less from consumers and workers when their incomes fall and more when their incomes rise.

In the end, it is important to recognize that in any type of economic system, including a market economy, some problems exist that can never be entirely or permanently solved. These problems have to be studied pragmatically on a case-by-case basis, with a careful consideration of the economic and political forces that influence them. And it is at this juncture that a democratic political system - one which encourages dissent and open discussion of public issues - can contribute most effectively to the operation of a free-market economy.

2. Possible prices and incomes policy for Canada.

In Australia, "The Accords" of the Labor governments between 1983 and 1995 are good examples of an incomes policy at work. The Accords were a social contract based on consensus and cooperation between the Federal Government and the Trade Unions (ACTU). The Accords had the basic elements of a centralised wage system, with minimum wages and specified working conditions for a number of occupations under Federal awards.

The Accords attempted to reduce the levels of inflation, industrial disputation and unemployment.

The successes of the Accords, Mark 1 to Mark V, were reflected in a reduction in the inflation rate, from 11.5% in June 1983 to 7.4% in June 1989. During the same period unemployment fell from 9.6% to 6.6% and industrial disputation decreased by 60%.

The government of Canada should learn from these experiences of other successful countries and implement a suitable income policy to counter the effect of inflation that could be induced by the world prices.

3. Diversification.

The diversification argument is used because a country wants to become more flexible and be able to adjust quickly to changes in global demand. Developing countries especially use this argument because they have a narrow export base and need protection to develop new manufacturing industries Eg. Taiwan which has virtually escaped the Asian Crisis of the 1990s. . Diversification would help spread the risk and make the economy less susceptible to sudden changes in demand and price decreases of commodities.

The problem is that scarce resources are being diverted into industries that may not be able to survive once protection is removed.

4. Defence and self-sufficiency.

There are some countries that put forward non-economic arguments for the protection of certain industries. For example a country may wish to reduce dependence on imports and increase its self-sufficiency in industries such as communication, shipbuilding, transportation and defence capabilities that are important to the security of the country. These goods and services are produced domestically even though they could be purchased more cheaply from international markets.

These arguments are based on social and political reasons and not economic theory. Self-sufficiency may then come at the expense of higher living standards gained from free trade.

5. Responsible Fiscal Policies.

The challenges Canada faces in sustaining its economic performance will shape the direction of fiscal policy in the years ahead. The challenges will translate into additional pressures on public finances and will influence future decisions about the content of government expenditure programmes and the structure of the tax system.

As with households, governments must manage budgets so they can meet their financial commitments, including regular expenses and debt repayments, from current and expected future income. In many other developed countries, this will mean cutting spending or raising taxes to reduce government debt to levels that can be serviced through future tax and other government revenues.

Fortunately Canada does not face such stark choices. Responsible management of revenue and expenditure has resulted in a succession of budget surpluses. Those surpluses have been used to repay debt. Government debt is now at levels that are among the lowest in the OECD (OECD 2004b).

The task going forward is to ensure that policies safeguard the sound fiscal position and that budgetary decisions are consistent with promoting productivity and participation. This means maintaining a responsible approach to government expenditures and securing a tax base that can fund those expenditures in an efficient and equitable manner. It also means managing pressures and risks to revenue or expenditure so future governments can continue to provide essential goods and services in a manner that promotes fairness in distributing public resources between generations of Canadians. Maintaining a responsible fiscal position is important to maintaining low inflation and low interest rates today, thereby providing a more stable environment for households and firms to make investment decisions.

The sustainability of fiscal policy depends not only on decisions made in the budget, but on the range of economic and social policies needed to provide higher income levels into the future. Critically, Canada needs to take advantage of opportunities to secure higher national income through trade, including with growing economies such as China and India. Canada's current fiscal position in part reflects the dividends of a positive international engagement strategy.