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Fiscal Policy Must Reinforce Monetary Policy Restraint

Although headline inflation has retreated from its peak, a return to its target rate will require fiscal policy to reinforce monetary policy restraint, says a Fraser Institute report. In ‘Canada’s Fiscal Policy Has Undermined Efforts to Tackle Inflation,’ Philip Cross, a senior fellow at the institute, says using monetary policy alone to rein in inflation risks an outcome where inflation remains elevated while the economy stagnates. Persistent inflation would keep interest rates high and, together with slow growth, would put continued upward pressure on government deficits. Monetary policy and fiscal policy must work together to reduce inflation, he says, noting that high government spending and deficits undermined the credibility of monetary policy in the 1960s and 1970s. Then, tight money accompanied by fiscal restraint and regulatory reform combined to cure inflation in the early 1980s and prevented a resurgence in Canada in the early 1990s The best way to avoid such an outcome is for Canada’s fiscal policy to align with monetary policy, he says.

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