When it comes to fiscal discipline, the federal Liberal government has often acted like a lapsed church-goer.
It knows all the right things to say. It might even believe in those things, as good and cherished values to which to aspire. But in day-to-day life, it strays from the righteous fiscal path.
So when Deputy Prime Minister and Finance Minister Chrystia Freeland talks, as she did at last week’s federal cabinet retreat, about taking care “to continue to take a fiscally prudent approach,” we start reaching for a grain or two of salt. After more than seven years with this government, we’ve grown used to its version of “fiscally prudent” being considerably looser than previous generations of Liberals with their aversion to deficits and strict fiscal anchors.
Maybe 2023 is a good time for this government to refind its fiscal religion. This year will truly test the government’s discipline.
An economic slowdown – perhaps one worthy of the term “recession” – is headed our way, fast. But we’ll have to face it down while still trying to overcome the country’s worst inflation problem in four decades.
The typical fiscal recipe for a recession is to increase spending to support hard-hit individuals and sectors, and to help stimulate economic activity. These Liberals are well-practised at that sort of approach. It’s also the kind of thing they like to do; it suits their approach to governing.
But stimulus spending would work at cross purposes to the fight against inflation, which has been led by the Bank of Canada and its aggressive interest-rate increases. The central bank is explicitly trying to slow the economy, to cool inflationary pressures. It would be decidedly unhelpful if government spending poured fresh fuel on the inflation fire.
In the longer run, the inflation fight is, without question, the country’s more important economic imperative. The government must resist temptation. If there was ever a wrong downturn for fiscal stimulus, this is it.
But Prime Minister Justin Trudeau and his team will feel pressure. They have election promises to fill and key initiatives to fund – including major (and costly) priorities such as health care and climate change. And if the country slips into even a moderate recession, the government will have an electorate and an opposition demanding it do something to ease Canadians’ pain.
“I’m quite wary of some sort of big, new fiscal spend,” said University of British Columbia economist Kevin Milligan, one of three outside economic experts (along with former Bank of Canada senior deputy governor Carolyn Wilkins and Statistics Canada chief statistician Anil Arora) who briefed cabinet at last week’s retreat.
What worries Prof. Milligan is that if the government decides to try to ease Canadians’ recession pain with an ill-conceived spending package, it would force the Bank of Canada to turn up the interest-rate heat even more to counter the stimulative impact on inflation.
“The Bank of Canada is going to counteract that pretty quickly,” he said in an interview.
What sort of “big, new fiscal spend” would be big enough to force the Bank of Canada to respond? Ms. Wilkins told reporters after the briefing that something in the neighbourhood of “$5-billion to $7-billion” would probably be equivalent to a quarter-point cut in the central bank’s policy interest rate. So, a spending injection of about 0.3 per cent of gross domestic product, or about 1.3 per cent of federal revenues, would require a quarter-point rate hike to offset it.
It implies that anything beyond a modest, targeted support program to aid the hardest-hit and most vulnerable Canadians would be counterproductive. The government would trade reduced pain from the recession for increased pain in the inflation fight. And the latter would last longer.
And Ms. Wilkins argued that because of the country’s high levels of household debt, the economy is particularly vulnerable to further rate hikes. “We don’t want more interest-rate increases than are absolutely necessary to get [inflation] back to where we need to go.”
The reality is that even if it was a good idea for this government to inject fiscal stimulus into the coming downturn, it’s not going to have a pile of money to dip into anyway. A two-year boom of tax revenue is about to dry up, as the post-COVID-crisis surge in nominal GDP is replaced by a year of little to no growth. Meanwhile, inflation has hit the government, too, driving up the cost of its expenses.
“The underlying pressures are for a much tighter budget situation,” Prof. Milligan said. “They really have very limited room to manoeuvre.”
So, the Liberals would be wise to, mostly, sit on their hands if and when the recession hits. They’ll have to resist their inclinations to do something – and, from a political perspective, to be seen doing something. But letting the economy slow down, staying out of its way, not crossing purposes with the Bank of Canada’s inflation battle – that will ultimately better serve the country’s economic health.
“It may seem really difficult now to go through this period of slower growth that we’re expecting to see, [and] higher unemployment,” Ms. Wilkins said. “But on the other side, we’ll be in much better shape than if we’re impatient.”