David Rosenberg’s memo to Ottawa: It’s time to bring out the fiscal guns

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The federal government can actually run deficits of $24-billion a year out to 2020 and that would leave the debt-to-GDP ratio at today's level (31 per cent), which is still less than half the average for the Organization for Economic Co-operation and Development.

Now, if Ottawa had the desire in the coming federal budget to bring the debt-to-GDP ratio in line with the OECD average of 72 per cent (the accounting is slightly different here, as it puts Canada at 40 per cent rather than 31 per cent, but this is simply for illustrative purposes, so just ignoring this for now), that would mean the government could run deficits in excess of $40-billion on average over a five-year span.

So my message to the new government is to begin to fight the economic forces with fiscal policy and stop this multiyear strategy of having the Bank of Canada shoulder all the responsibility via the currency, which is a double-edged sword – yes, it makes exports more competitive, but it increases the costs of imported inputs to production and capital goods.

Now is not the time to cheapen up the currency any further for a quick fix that only helps the winners, with long and variable lags in any event, not to mention how the losers (consumers, in other words) are ultimately affected. Check out imported food costs and you will see that this policy of continuing to cheapen up the currency to buy up U.S. market share is extremely regressive (not to mention akin to the country accepting a national pay cut).

Now is the time for a swift and decisive fiscal boost – if the government wasn't spending years strengthening our nation's balance sheet to use it as a weapon against downside economic risks as is the case today, then what was the point of it all?

We stopped being a fiscal basket case nearly 15 years ago – we really no longer have anything to prove to the world when it comes to flashing our budget-balancing credentials.

The Bank of Canada, however, has limited tools, really, to offset the sudden loss of capital spending in the energy patch.

Fiscal policy is a much more effective response, and unlike the monetary response, there are no lagged effects for which to wait.

What is Ottawa waiting for?

Back in that last period of a supply-side energy shock in 1985-86 that drove Alberta into recession and cut nationwide economic growth by half, not only did the Bank of Canada slice rates two percentage points (which Stephen Poloz cannot do today) but the Conservative-led government of the day was pursuing a far-less-stringent fiscal posture.

Compare and contrast:

• Today, the fiscal balance in cyclically adjusted terms is basically flat while it was a deficit of $36-billion in 1986 (allowed to expand from $29-billion in 1985); in 1985-86, the cyclically adjusted deficit was allowed to rise to 8 per cent from 7 per cent relative to potential GDP – fiscal policy under the Mulroney regime was appropriately loose and helped pave the way for the boom in the late 1980s.
• Ottawa was running a primary budget deficit (the balance excluding interest payments) of around $12-billion (3 per cent of GDP) in 1985-86; today it has a primary surplus of $28-billion (1.4 per cent of GDP).
• Finally, the current federal government is spending 90 cents on program expenditures for every dollar it is bringing in from the revenue base; in that 1985-86 period, Ottawa was spending nearly 20 per cent more on programs (excluding interest outlays) than it was siphoning off in terms of revenues from the economy.

In other words, fiscal policy is far too tight in view of the challenges ahead.

But if there is to be no fiscal response, and given that the Bank of Canada is running low on bullets even if it views the new effective lower bound for policy rates being in negative territory, the stimulus is then going to have come from the currency.

Now you know why the Canadian dollar is also known as the "loonie" – it is a diving bird, one that is more prone now to sink than to float until either the oil price stabilizes (out of our hands) or until fiscal policy replaces monetary policy as the primary source of stimulus.

David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.