Oil Sands Truth: Shut Down the Tar Sands

"Alberta's inflation is everyone's interest"

Alberta's inflation is everyone's interest
Globe and Mail Update
July 11, 2007 at 11:45 PM EDT

Interest rates are not the economic equivalent of the neutron bomb, reducing prices but leaving the real economy untouched. Indeed, when the Bank of Canada raises interest rates to reduce inflation, it works by deflating the whole economy — fewer people find jobs, families have a harder time paying mortgages and car loans, businesses invest less because it costs more to borrow capital. In short, there are real costs to higher interest rates.

On average, in Canada, inflation is higher than the bank's target of 2 per cent, but that average disguises a lot. In both Ontario and Quebec, the year-over-year all-items price increase is below 2 per cent.

Alberta's is 5 per cent. When David Dodge raises interest rates, it is to slow down the Alberta economy. The rest of Canada is collateral damage. Because Alberta has permitted uncontrolled exploitation of its oil and gas resources, there is a shortage of almost everything in that province. There is a shortage of housing, roads, public transit, sewers, hospitals, schools — you name it — as well as of the human resources needed to correct the shortages. This inevitably drives prices sky high. So the bank acts to bring price increases down by raising interest rates until it hurts enough to slow economic growth.

We have seen this horror movie before. In the early 1990s, as the Bank of Canada took interest rates through the ceiling, Ottawa and the provinces continued borrowing money to stimulate the economy. But when there is a contradiction between monetary policy and fiscal policy, monetary policy always wins. Governments cannot spend their way out of the negative effects of higher interest rates, doing so only causes the bank to raise rates higher.

Today, we have an analogous situation in Alberta, but this time it is caused by the super-stimulation of high oil prices and the fevered search to exploit every possible hydrocarbon resource all at the same time. Higher interest rates will eventually throw a wet blanket over these economic fires. But the blanket will cover all of Canada, not just Alberta. And with the higher loonie that interest-rate hikes will reinforce, the rest of Canada's economy will already be at a snail's pace. Higher interest rates are a not a good solution.

The better solution is sensible economic policy in Alberta. This Wild West of exploitation needs to be inhibited by a government policy of moderate restraint, such as a moratorium on new leases for exploration; the discouragement of any further oil-sands projects at least until the infrastructure to house and feed workers has caught up; the investment of excess government revenue outside of Alberta and even outside of Canada; a fair increase in royalties in the oil sands, at least to international norms; and much more careful assessment of the environmental costs of projects against their economic benefits. One way or another, the Alberta economy will have to cool off. It can happen either through interest rates or through good provincial government policy, but Albertans should be aware that it will happen.

The question for Albertans is whether they will demand a reasonable government policy that can ensure the province gets some long-term benefits out of the needed pause, or whether they are just going to go hell-bound for leather while the bank does its thing. The question for the rest of us is how much we are going to have to pay if Alberta continues in its unrestrained ways.

Michael Mendelson is senior scholar at the Caledon Institute of Social Policy.

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