lates to so-called ‘hysteresis’, which refers to the case where a variable that has been shifted by some external force does not return to its original state once the external force has been lifted. In the Canadian macroeconomy, it is argued that hysteresis took place when the recession increased the ‘natural’ unemployment rate by creating new structural unemployment. As such, the economy’s self-stabilising tendency was hampered which damaged the economy because its potential level of real output decreased. To some degree, this explanation helps explain the stubbornly high rates of Canadian unemployment in the 1990s. Critics are also quick to point to another important cost of the Bank of Canada’s contractionary policies during the early 1990s. High short-term interest rates have caused the interest bill on outstanding government debt to increase. And , by pushing down both real income and employment, the Bank has reduced government tax revenues. A vicious cycle has been the consequence, with the federal government’s added interest obligations and sagging tax intake forcing it to run higher yearly deficits which have increased public debt even further. Thus, despite the success of reaching low inflation targets, low inflation monetary policy does tend to raise unemployment, either directly or indirectly. This can occur through its effects on investment or otherwise, unless the policy generates a great increase in confidence and public expenditure cuts. As the Canadian case demonstrates, this may not be possible. The danger of a narrowly focused monetary policy, then, is that if unemployment rises more than expected, which may well happen, political pressures are likely to be generated leading to the abandonment of the experiment. In Canada, the pressure is increasing, and though virtually independent of the government, the Bank of Canada may not be able to withstand the costs of the exp...
