For a couple of decades, there was a broad consensus in Canada on fiscal and monetary policy. Big structural deficits were very bad, and keeping inflation low and within a targeted range was very good.
The fiscal consensus started to dissolve in 2015, when the Trudeau Liberals won a majority built in part on a pledge of limited deficits. “Limited” was quickly abandoned, and red ink became a fixture in Ottawa. Then came the pandemic’s mega-deficits – followed by the fiscal delusion on the part of the federal Liberals that ultralow interest rates removed any constraint on their spending ambitions.
Now, the consensus about low, stable inflation also looks to be crumbling, as the Bank of Canada ratchets up its policy rate to its highest level in more than two decades. Of course, a large part of the reason that the bank has had to act so aggressively is the abandonment of fiscal responsibility in Ottawa.
The response from the NDP and sympathetically minded progressive economists is to play down the economic risks of inflation, while portraying the central bank’s rate hikes as an attack on lower-income Canadians.
Bizarrely, some on the left are indulging the nonsensical claim that rising interest rates fuel, rather than dampen, inflation. True, interest rate hikes do increase the carrying cost of mortgages and add to the Consumer Price Index (with fresh data out on Tuesday morning). But there is zero doubt that the effect of rate hikes is to push down consumer and business spending and thereby reduce inflationary pressures. To claim otherwise is akin to complaining that you get soaked when you use a life jacket – correct, in a deliberately specific way, but missing the broader point.
The Liberals managed to fuzzify the bank’s inflation-fighting mandate by requiring it in late 2021 “to actively seek the maximum sustainable level of employment when conditions warrant.” The Conservatives are sticking with their anti-inflation stance, even as they decry increasing interest costs. But Leader Pierre Poilievre’s attacks on Governor Tiff Macklem have hurt confidence in the central bank. Still, the Tories say they would fight inflation by capping federal spending.
Which is the point at which the government and its apologists typically sniff that global pressures, not Ottawa’s actions, drove inflation to 40-year highs last year. That defence has been trotted out innumerable times, including in the 2022 and 2023 budget speeches by Finance Minister Chrystia Freeland, and by Prime Minister Justin Trudeau last week.
However, as an analysis last fall from the International Monetary Fund makes clear, that deflection defence has huge holes. According to the IMF, there were two tranches in the wave of inflation that hit advanced economies postpandemic. The second part of that wave was attributable to global supply shocks from Russia’s invasion of Ukraine, particularly a surge in energy prices.
But before that, the start of inflationary pressures had their roots in the massive fiscal stimulus that most countries used to compensate – in most cases, overcompensate – for the economic downturn brought on by the coronavirus and lockdowns. The IMF says its calculations indicate that inflation rose by 0.8 percentage points for fiscal stimulus equal to 10 per cent of gross domestic product. Canada’s stimulus was around 15 per cent of GDP, meaning that deficit spending increased inflation by about 1.2 percentage points.
Certainly some of spending was not only desirable, but necessary. But Ottawa has kept on spending: projected expenses for the current fiscal year are nearly $50-billion higher than what the government forecast in its 2021 budget. That added $50-billion is, emphatically, not a response to the pandemic. It was the bill for a series of Liberal spending choices, including, ironically enough, increased payments to low-income households to offset the impact of inflation that was in good measure driven by earlier overspending. (Provincial governments of all political stripes have done the same.)
The irony is lost on the Liberals, who continue to see inflation as one more reason to spend, while doing their best to erase any connection between their own fiscal irresponsibility and the pain that the Bank of Canada is being forced to inflict on Canadians. The NDP and large swathes of the progressive left are all too happy to indulge that fiction, allowing them to demand higher taxes and spending as a salve.
What both the Liberals and NDP fail to acknowledge is this: there is no free lunch. And the longer you wait to pay, the bigger the tab.