Prime Minister Justin Trudeau and Deputy Prime Minister joins Minister of Finance Chrystia Freeland as they make their way to the House of Commons on Parliament Hill for the tabling of the Fall Economic Statement in Ottawa, on Nov. 3.Justin Tang/The Canadian Press
In its fall update Thursday, the federal Finance Department laid out two scenarios for how the economy and government finances might play out over the next year or two.
One, which represents the government’s official projections, depicts an economy that skirts a recession in 2023, and sees a steady decline of budget deficits back to pre-COVID-19 levels within a couple of years. It’s an image of soft landings and fiscal health.
The other, which the government calls its “downside scenario,” envisions a recession beginning early next year, and an economic contraction of about 1.6 per cent. The government would face significantly higher deficits that would be knocked off their downward path, at least temporarily.
We might want to flip those two scenarios in our heads. The optimistic premises on which the government’s official estimates are based have, for the most part, already sailed. The downside scenario may be a bit more bleak than we’re headed, but it’s now probably closer to reality.
As is the Canadian government’s standard practice since 1994, the official projections are derived from a survey of private-sector economists. But in this instance, those economists were polled in early September – two months ago. In the current climate, those forecasts are fossils.
Since then, many of the same private-sector economists polled by the government have turned more pessimistic, with growth forecasts falling to near-zero for next year and recession warnings becoming commonplace. The Bank of Canada itself projected just last week that growth would stall over the next three quarters, and allowed that it could easily slip into negative territory.
Hence the government’s decision to present what is, essentially, an alternative reality for its fall economic and fiscal outlook.
“As we were putting together the fall economic statement, we saw that some of the predictions … were getting a little more negative. So we thought it was also appropriate to also present a downside scenario,” Finance Minister Chrystia Freeland said in a news conference Thursday.
The government’s downside is even darker than where most private-sector economists now stand. It envisions the Canadian economy contracting by almost 1 per cent in 2023. Among the five Canadian major banks that have issued forecasts since mid-October, the average 2023 growth forecast is 0.4 per cent, and none of them project an outright contraction for the year.
But economists are still in the process of revising their forecasts lower; the outlook, quite clearly, is deteriorating, and there’s a compelling and still growing case for a recession in 2023. Interest rates will almost certainly peak higher than forecasters expected a couple of months ago, and that will impose a significant economic drag. We’re certainly heading away from the fall update’s base case and toward the downside scenario, even if we don’t quite slip that far.
So how, exactly, is Ottawa bracing for the downside risk? Well, mostly by doing as little as possible. Which itself is an act of considerable discipline for the Liberal government of Justin Trudeau.
This is a government that, prior to the pandemic, increased its program spending an average of more than 6 per cent a year. It made a habit of spending any found money in years when its deficits were coming in below budget.
In this update, the government estimated a decline in program spending of 6.6 per cent in the current 2022-23 budget year – a year in which revenue grew by nearly 8 per cent. In 2023-24, the government has budgeted a program spending increase of a thin 1.4 per cent.
Rather than lean fiscal policy into an anticipated slowdown – as the Trudeau Liberals might well have done in the past – the government has opted to, for the most part, stay out of the way. This might fly in the face of the government’s Keynesian instincts, and upset critics who have been calling for more support for Canadians struggling with high inflation and rising borrowing costs.
But it will be quietly applauded by the country’s central bankers. The Bank of Canada has been raising interest rates precisely to orchestrate a slowdown in the country’s overheated economy, on order to tame inflation. The last thing it needed was Ottawa further stimulating the economy with new spending; the government obliged by holding its fire.
As a result, even the downside scenario doesn’t seriously threaten the government’s return to fiscal stability and manageable deficits following the COVID-19 crisis, though it would be a setback. We’re talking about budget deficits in the $50-billion range for the next couple of years, rather than something closer to $30-billion, and falling, in the government’s official estimate. If, of course, the Liberals don’t blink and slip back into their spend-and-stimulate tendencies.
“I really believe people should take comfort from that downside scenario,” Ms. Freeland said. “Even if things are significantly worse than private-sector economists were predicting when we surveyed them, Canada’s fiscal position is absolutely sound, and Canada gets through this in really good shape.”
Still, there’s some cause for discomfort for Canadians in being presented with two sets of competing projections. It’s not the first time budget makers have relied on stale private-sector forecasts to build the federal budget. It’s problematic on general principle to have bureaucrats overriding those independent forecasts.
At the very least, Ottawa needs to revisit its methods and timing for polling private-sector forecasters. The downside scenario might well prove a very prudent and useful exercise. But duelling projections is not the best budgeting habit to get into.