Canadian public economics policy - Essay Example

Government spending has been used to determine the size of a government because it constitutes a large part of GDP, such that increasing it will effectively increase GDP. Furthermore, because government spending increases inflation as a result of increased money supply; increases deficits by choosing not to increase revenues vis--vis spending; and increases debts by choosing to borrow funds to finance spending, it makes a logical measure of the size of government. While this observation is theoretically sound, the actual effect of government spending is inconsistent.

First, with regard to tax breaks and subsidies, because of its varying effects on the behaviour of businesses, the effect of government spending varies as well. For example, Canada's Five Year $100 billion Tax Reduction Plan should lead to a decrease in the size of government. However, because it makes Canada's business climate more competitive, it may induce corporations and business owners to move operations to, or increase operations in Canada, leading to an increase in the size of government instead.

Second, it will also have varying effects on other components of GDP. . as pensions and loan guarantees that are not always accounted for, but nonetheless exists, government spending is rendered an unreliable measure of the size of government. (375 words)Question 2 A debt management policy utilizing government bonds indexed to inflation is one way governments illustrate credibility in fighting inflation by intentionally removing incentives to inflate. In this respect, the Canadian government is committed to fighting inflation because as part of its debt management policy, it issues security bonds, indexed to the country consumer price index (CPI).

A government's credibility in fighting inflation through indexed bonds can be illustrated through the differences between conventional and indexed bonds. With regard to the use of conventional bonds, a government debt's real value decreases in accordance to increases in inflation because as borrower, it will only have to pay a particular amount, based on nominal terms, regardless of changes in a currency's purchasing power caused by inflation. Since government financing through bonds indicate an implied obligation to pay in the future, conventional, nominal bonds eventually decreases in real value as the purchasing power decreases through yearly inflation.

While these risks can be reduced through setting nominal interest rates that forecast possible increases in inflation, they are not secured from its unexpected sharp rises or declines. Thus, if inflation increases sharply, governments will require fewer resources to pay for its bonds transferring the loss in real value to the bondholder. Contrary to conventional bonds, indexed bonds, by linking their nominal terms to inflation specifies a more stable value for bondholders because the burden caused by inflation is placed on the