unemployment rate in Canada.

Commentary

The Coronavirus pandemic has significantly changed the unemployment rate in Canada. The article suggests an increase in the unemployment rate “from 7.5 per cent to 8.1 per cent” caused by the change in aggregate demand. The occurrence of cyclical unemployment (demand deficient unemployment occurs in recession) can lead to many negative consequences such as a loss of real GDP and a loss of income for unemployed workers. This problem of unemployment can be eased by imposing government policy to correct the low aggregate demand.

The diagram above illustrates the change unemployment rate arising from low aggregate demand in Canada in the short run. Short run refers to the time period where at least one factors of production is fixed. As shown in the diagram, the Canadian economy is initially at point a, producing the potential level of output Q1, with 0 cyclical unemployment. A decrease in AD caused by COVID-19 leads to a left shift from AD1 to AD2. This causes a recessionary gap between Q2 and Q1 at the shaded triangular area while the real GDP falls from Q1 to Q2. The economy then moves from point a to point b, where the price level decreases from P1 to P2 to achieve the new equilibrium. This suggests that there is not enough total demand in the economy to make it worth while to produce the potential GDP using the same amount of labour (GDP at Q2 < potential GDP at Q1) means that firms have to lower their demand for labour by firing workers, or else they will end up earning deficits: producing lower output and receiving lower revenue with the same costs of production (paying workers same amount of wages as before). Thus, lower demand for labour has caused the unemployment in Canada “climbed to 486,000”.

This decrease in aggregate demand that leads to the change unemployment is contributed by two components: decrease in consumption and investment in Canada. Due to COVID-19, consumer confidence has reduced, as they are not optimistic about their future income and the future of economy. Thus, consumers with low purchasing power are no more demanding for more goods and services now, causing consumption to decreases. A lot of people therefore lost their jobs: “Canada’s labour market lost 207,000 jobs last month”, because the fall in AD will prompt firms to decrease output and so a fall in the demand for labour. At the same time, entrepreneurs’ loss their business confidence, causing investment to decreases. This means that there will be less labour-used capital supplied, which increases the unemployment rate.

Expansionary fiscal policy may be imposed by the Canadian government to ease this problem of high unemployment in Canada. Expansionary fiscal policy is aimed at increasing aggregate demand to lower cyclical unemployment by cutting direct taxation (both income&business) and increasing government spending. Figure 2 illustrates the effect of the imposition of fiscal policy in Canada. The economy is currently at point b, where the price level is at P1 and the real GDP is at Q1. After the imposition of fiscal policy, the aggregate demand increases: AD curve right shifts from AD1 to AD2. This increase in aggregate demand is caused by three factors: cutting direct income taxes, cutting direct business taxes and increasing government spending. Cutting direct income taxes can increase the consumption in Canada as the consumers now have higher disposable income to spend, which decreases the unemployment rate (firms have higher demand for labor to produce goods). Cutting business taxes also contributes to the increase in AD because it increases the investment in Canada by encouraging more businesses to invest. This means that more workers are being demanded to use the newly invested capitals, which reduces the unemployment rate. Increase in government spending may provide more job positions (setting up public sectors), further shifting the AD curve to AD2. This right shift in AD also eliminates the recessionary gap (blue triangular area), making the Canadian economy back to normal (movement from point b to point a). The price level therefore increases from P1 to P2 (to achieve the equilibrium).

To evaluate, the advantage of the expansionary fiscal policy is that it is essential to reduce unemployment by pulling the Canadian economy out of the recession(increasing AD), since the market forces are unable to achieve allocative efficiency(as shown in Figure 2). If not, the Canadian economy may be stuck in a recessionary gap indefinitely, meaning that the unemployed workers might be unemployed permanently. Apart from that, fiscal policy also has a direct impact of government spending on aggregate demand. This means that the Canadian government is spending more money on “relief benefits”, benefiting unemployed people. Nevertheless, the imposition of fiscal policy may be more effective with the implementation of supply-side policies: increase employment by improving incentive (lowering taxes) and making the labour market more responsive (weakening the power of trade union).

However, there are some limitations of imposing an expansionary fiscal policy as well—the problem of low unemployment cannot be completely eliminated using ideal economic model illustrates in figure 2. Specifically, cutting income and business taxes in recession may not be very effective in increasing aggregate demand, because people are likely to save the additional disposable income rather than spend it due to low confidence in the future. Apart from that, the Canadian government is likely to borrow money through selling bonds to the public, firms and banks, in order to finance the expansionary fiscal policy. This can lead to crowding out effect: less money supply in the circulation(increase in interest rate). This discourages consumption and investment, since people now receive higher income from saving. The increase in G therefore crowds-out C and I and so counteracts the intention of expansionary policy on AD. Thus, supply-side policies (e.g. abolishing minimum wage legislation) may serve as an alternative solution to lower the unemployment in Canada.

In conclusion, I believe that imposing fiscal policy is a possibly solution of reducing the change in unemployment in Canada. Although there are some limitations of fiscal policy, the imposition of fiscal policy can still reduce the unemployment to some extent. For example, unlike cutting direct taxes, increasing government spending can effectively and directly increase aggregate demand without being affected by the recession. In addition, the problem of “employment insurance” can be solved using fiscal policy as well.