Prime Minister Justin Trudeau and Deputy Prime Minister and Minister of Finance Chrystia Freeland arrive to deliver the federal budget in the House of Commons on Parliament Hill in Ottawa, on March 28.Justin Tang/The Canadian Press
Claude Lavoie was director-general of economic studies and policy analysis at the Department of Finance from 2008 to 2023. He has represented Canada at OECD meetings and has received many honours, including the Queen’s Diamond Jubilee Medal.
Fans of the derisory “Justinflation” hashtag and institutions such as the Swiss-based Bank for International Settlements are calling for public spending cuts to help fight inflation. Public spending cuts mean the Bank of Canada will not have to raise rates as much (or keep them high as long) to bring inflation back to its 2-per-cent target.
While this may sound like a good thing, the resulting lower rates will not help Canadians curb their debt addiction, and large spending cuts will indirectly discourage households to do a well-overdue clean up of their balance sheets.
Decades of low interest rates have led to high levels of household debt (and housing prices), which has been a Sword of Damocles – a hanging threat – over the economy for many years. Canadian households are more in debt than those in any other G7 country.
Lower interest rates, while a temporary relief, will only exacerbate the debt situation. And a fall in government spending, depending on where the reductions take place, may mean fewer investments in public infrastructure or affordable housing – which would have helped reduce inflation pressures in the future. Less public spending would also mean less generous support to vulnerable households who will be affected by the reduction in aggregate demand.
The government and the Bank of Canada should not work at cross-purposes, but when deciding how much monetary and fiscal policy to use to control inflation, the mix should certainly be tilted toward monetary policy (or tighter financial regulations) if we care about the future robustness of the economy.
Contrary to household debt, higher public debt, which results from higher government spending, isn’t a big deal. We cannot look at public and private debt with the same lens. What mostly matters for a government borrowing room is its ability to issue debt in its own currency. This depends not only on its own debt level but, among others, on the total debt that all levels of government and the private sector have contracted with the rest of the world.
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In this regard, Canada is strong and is in a net asset position relative to the rest of the world. At 30 per cent, our net public debt as a share of GDP is among the lowest. The U.S., Britain and France public debts are at about 100 per cent and Japan is at about 200 per cent. Yet, none of these countries are having difficulty borrowing on external markets.
This is not an endorsement for radically increasing public debt in Canada. There are costs associated with that. We need to be prudent as the future is uncertain and Canada’s fiscal situation may not be as rosy as the federal government paints it.
In the last budget, the federal government projects its debt-to-GDP ratio to fall below 20 per cent by 2050 “despite adverse demographic trends” such as an aging population and projected increases in borrowing costs.
But what about the adverse impacts of climate change and of reaching net zero? The Canada Energy Dashboard, a website developed by Navius Research and sponsored by Natural Resources Canada, suggests a debt-to-GDP ratio 15 percentage points higher in 2050 in a net-zero scenario than in the federal budget projections.
The federal projections also have debatable assumptions on the future generosity of certain programs (such as Old Age Security) and don’t consider the evolution of the provincial fiscal situation, which affects the federal government’s ability to borrow.
But these considerations do not change the main point that the federal government still has some borrowing room. We should not fall for fiscal fear mongering about Canada’s debt.
The debt debate is a frequently played card to limit government spending. Policy makers like to use it as an excuse to say “no” to their friends or bad ideas from their Ministers, and at times to please corporate donors who have a vested interest in keeping the government small.
The fact that we have plenty of borrowing room should not even be part of the debate. The central criterion for judging new fiscal measures should be their ability to bring tangible, sustainable additional benefits to Canadians’ quality of life. Not the availability of fiscal space.
The real challenge is finding an effective body to make these judgments, to wade past government proclamations and to add the voice of Canadians to the debate.
Perhaps the budget 2022 promised (but never created) Canada Council of Economic Advisers could provide transparent, publicly available arm-length evaluation of policies. This could be a great alternative to crying wolf to limit public spending.