Macroeconomic effects and sensitivity analysis

Abstract

The University of Toronto's FOCUS model of the Canadian economy is used to examine the economic implications of the Free Trade Agreement with the United States. Drawing upon the results of the companion article by Richard Harris, the model depicts the impact of the agreement on output, incomes, employment, prices, and the exchange rate through the next 12 years. Alternative experiments test the sensitivity of the results to the wide range of the assumptions about policy and economic behavior that must be made to conduct a meaningful study of the agreement. Our best estimate of the aggregate economic impact of the agreement is an increase in the real rate of growth of 0.4 percent per year over the 10-year transition period. There will be downward pressures on the price level, especially towards the end of the century, and temporary improvements in the unemployment rate. There are significant permanent gains in incomes. Although near-term pressures on the current account could weaken the Canadian dollar, over the longer term the agreement should clearly strengthen the dollar. These results are insensitive to reasonable variations in almost all the necessary assumptions. The results are, however, highly sensitive to the estimates of improvements in productivity growth obtained by Harris and other researchers. If Canada does not achieve reasonably secure access to the large U.S. market during the transition period, or if Canadian industry is currently relatively more efficient and “world scale” than is estimated, then the productivity gains could be quite modest, and the economic benefits of the agreement would be reduced, but not eliminated.