On taming inflation, Liberals’ fiscal policy is more a part of the problem than the solution

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Chrystia Freeland stood before a Bay Street audience last week and declared that Ottawa has embraced “fiscal restraint.”

Economists – and the cold, hard numbers – beg to differ.

In a key economic speech to an Empire Club luncheon, the Deputy Prime Minister and Finance Minister asserted that she had very intentionally pulled back the reins in her April budget, mindful not to pile onto an economy already grappling with excess demand and high inflation.

“I know that my fiscal prudence surprised many in this room,” she said.

How is Chrystia Freeland fighting inflation? By not sending you a cheque. She’s right

What surprised many in the room was that Ms. Freeland would boast that this budget was such a success. Government spending has, since the COVID-19 pandemic began, been highly stimulative to an economy that now looks overheated. The data suggest Ottawa’s spending is still boosting demand, meaning it is contributing more to the inflation problem than to its solution.

“The budget balance is improving,” Bank of Nova Scotia chief economist Jean-Francois Perrault, who sat at the head table with Ms. Freeland at the lunch, said in an interview. “But the government is not changing its underlying spending profile.”

“We’re not getting the impression that they’re doing a whole lot of effort to try to help the Bank of Canada on the inflation side.”

Not to suggest that the Finance Minister is trying to sell snake oil here. The meaning of “fiscal prudence” depends on how you choose to look at it.

If you’re measuring the government’s spending against the fiscal torrent of the pandemic, where emergency support programs blew up government finances in a way never seen before, then yes, the budget Ms. Freeland tabled looks pretty darned restrained.

The federal government’s budgeted 2022-23 deficit is down more than $60-billion from 2021-22, and down $275-billion from 2020-21. There has been, empirically and unquestionably, a massive reduction in spending. Coupled with strong growth in revenues (for which Ottawa can partially thank the effects of inflation), the ocean of government red ink is drying up into a more manageable lake, if not yet a small pond.

Ms. Freeland’s favoured yardstick – cited in her speech and in a news conference that followed – is how Canada is faring relative to its global peers in this deficit reduction. She’s happy to report that we’re tied with the United States for the fastest pace among the G7. Fair enough. Although being less sick than the other people around you in the emergency room doesn’t mean you’re healthy.

But this was a speech focused on Canada’s inflation problem, and what the government is doing about it. The question, then, isn’t merely whether spending is declining, nor where Canada stands in that regard against its peers. It’s whether fiscal policy remains overgenerous to such an extent that it is accelerating domestic demand and, thus, contributing to the country’s inflation pressures.

The federal government’s program spending in 2022-2023 is budgeted at the equivalent of nearly 16 per cent of gross domestic product – almost two percentage points higher than before the COVID-19 pandemic, and the biggest non-crisis budget footprint in nearly three decades.

By that measure, federal spending is still contributing a great deal more to overall demand in the economy than it was before the pandemic. And program spending as a proportion of GDP was at an eight-year high entering the crisis, suggesting fiscal policy was probably tilted toward being economically stimulative even before COVID-19 triggered a massive fiscal stimulus.

Mr. Perrault noted that even though pandemic-related supports have now faded from the budget’s bottom line, the government’s spending on public-sector wages and government-purchased goods and services – the things that represent the government’s own consumption – has not declined. This, he said, is the key way in which the government feeds overall demand in the economy, and it hasn’t retreated at all. (Employment in the federal public service – probably the biggest indicator of government consumption – is about 11 per cent higher than it was before the pandemic.)

Economists do give Ms. Freeland credit for having held off on some of the Liberals’ spending promises in last fall’s election campaign, which could have added considerably more to the budget’s bottom line. But even then, the net new spending the government did introduce “was still mildly stimulative, on the order of about 0.3 per cent of GDP,” Bank of Montreal chief economist Doug Porter said.

“That probably doesn’t qualify as landing in the ‘restraint’ column.”

Ms. Freeland hasn’t introduced new expenditures or tax cuts aimed at offsetting the inflation costs that Canadians are bearing; her speech focused on existing programs that rise with inflation and benefit segments of the population that get squeezed hardest by increasing consumer prices. She’s aware that more spending, even if it eases the immediate inflation pain for individuals, would ultimately compound the problem at this stage.

But merely not adding to the fire is not the same as helping extinguish it. Economists worry that Ottawa’s fiscal plan is still pulling in the wrong direction on inflation.

“Fiscal policy has every bit as much a role to play in dampening inflation as does monetary policy – as it likely did in firing up inflation globally in the first place,” Mr. Porter said. “And fiscal policy should definitely not get a pass in the inflation fight.”

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