North American governments’ continued spending stokes concerns about readiness for a downturn

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Across North America, guardians of the public purse are on a war footing in peacetime.

The world economy hasn't looked this good since before the global financial crisis. A synchronized swell of growth is creating jobs and fuelling consumer spending the world over, leaving virtually no major economy behind. In the United States, unemployment is at its lowest in nearly two decades. And Canada is fresh off a year in which it topped all Group of Seven countries in growth.

Both here and in the United States, the economy appears healthy enough to warrant some measure of restraint under the principles of sound fiscal policy: Be conservative during periods of strength, saving up resources that will be needed when the next recession hits.

And yet, governments are still resorting to the kind of spending meant to fight economic foes that are nowhere in sight. Deficits remain the order of the day. Finance ministers are still choosing stimulus over discipline, adding to public debt loads in the process.

Last month's federal budget projects an $18.1-billion deficit for the coming fiscal year and another $60.5-billion in red ink in the four years after that. And the Ontario provincial government, having spent a decade balancing the books after its post-financial-crisis spending blitz, said it plans to return to deficit when it tables its budget on Wednesday with a shortfall of up to $8-billion.

Meanwhile, deep tax cuts in the United States combined with new spending has blown a hole in Washington's budget at a time when the domestic economy is operating at close to full employment.

Central bankers seem to get that, as they gradually increase interest rates to stave off inflation and prevent economies from overheating. All of this new fiscal stimulus is pushing in the opposite direction at a time when the bustling economy doesn't really need the help.

"If they can't balance the books now, at this very strong stage of the cycle, they may never be able to," said Doug Porter, chief economist at the Bank of Montreal. "And as governments purposely weaken their finances now, it gives them less manoeuvring room and less firepower in the next downturn."

Already, Canada appears less prepared for an economic shock than it was a decade ago. Debt has increased materially on all fronts – government, household and corporate. And perpetual deficits will only further weaken the national balance sheet, making it unlikely that Canada will weather the next recession as well as it did the last.

These days, there is little trace of what was once a national fixation on balanced public finances in Canada. Through the mid-1990s and most of the 2000s, a campaign of "fiscal consolidation" slayed the federal deficit and ultimately cut the country's debt-to-GDP ratio in half from what had become an unsustainable debt load.

Starting in 1997-98, federal governments posted 11 straight annual budget surpluses, a streak only ended by the global financial crisis. Even then, balance was relinquished grudgingly. As late as November, 2008, more than two months after Lehman Brothers went bankrupt, and a financial calamity of historic proportions was taking shape, then-prime minister Stephen Harper was still clinging to the ideal of avoiding deficits. He finally relented after an attempt by the opposition parties to form a coalition government.

"Canada had a culture of caring about the fiscal position, not just about goodies and tax cuts. I worry that's being eroded," said Eric Lascelles, chief economist at RBC Global Asset Management.

U.S. politicians, including many self-declared fiscal conservatives, have offered up little resistance to a budget that seems designed to contend with a non-existent downturn. Next year's U.S. deficit is projected to be about US$1-trillion, or more than 5 per cent of forecast GDP. That's not quite approaching the crisis-era high of nearly 10 per cent, but it's still "enormous," Mr. Lascelles said. And it's not just taxes behind the U.S. budget crunch. A US$1.3-trillion spending bill proposes new funding for virtually every federal department and agency over two fiscal years.

"It goes against everything you learned in Economics 101," writes Avery Shenfeld, chief economist at CIBC World Markets. "But a case is being made these days for fiscal stimulus at the top of the business cycle." The rationale is that jolting the economy with stimulus makes room for central banks to hike rates as a counter-measure. Higher rates, in turn, allow for more dramatic monetary intervention when the next downturn hits.

Best, instead, to let central banks hike rates at their own pace, rather than risk putting too much strain on indebted consumers, Mr. Shenfeld said. The Bank of Canada, for its part, seems inclined to take a gradual approach for that very reason.

"The case for turning Keynes on his head is shaky on several grounds," Mr. Shenfeld said. And yet, the curious application of Keynesian stimulus at the top of the business cycle seems to be part of a continental trend.

In Ottawa's budget, there was little evidence of preparation for an eventual downturn, said Catherine Swift, president of Working Canadians, a taxpayer advocacy group. Frivolous spending now ignores the damage that will be wrought when a recession coincides with household debt levels, Ms. Swift said. "We're putting ourselves in a position of vulnerability. When we do tip over, it will be a long drop and a terrible climb out of it."

The continuing federal deficit is largely an extension of fiscal support designed to combat the crash in oil prices. Back in 2015, as a sputtering domestic economy became the dominant election issue, Justin Trudeau campaigned on a platform that included modest deficit spending before rebalancing the budget by 2019. At that time, U.S. crude oil prices were trading below US$40 a barrel amid a global oversupply, taking a heavy toll on Canada's resource-dependent economy.

"There was a reasonable case to be made at the time," Mr. Porter said. Unemployment had begun to creep higher, growth was vanishing and long-term bond yields were at record lows. "A lot of those conditions just aren't there any more," he said.

The kinds of conditions calling for deficits don't seem to be apparent in Ontario, either. The provincial economy has outperformed even Canada's over the past three years, Finance Minister Charles Sousa said in a speech earlier this month. He also used the occasion to suggest the province will be tabling a deficit budget on Wednesday. "Even though I have fought long and hard to slay the deficit and balance the books … I will not leave people behind," Mr. Sousa said.

Ontario's shortfall will be less than 1 per cent of provincial GDP, Mr. Sousa said, and the budget will set out a path back to balance. But as the Canadian fiscal experience has made clear through the years, the deficit track is a difficult one from which to get off.

"There is nothing so permanent as a temporary program," said Eveline Adomait, an assistant economics professor at the University of Guelph, quoting economist Milton Friedman. With the start of a provincial election campaign just a month away, Ontario Premier Kathleen Wynne has, in recent days, promised to dole out billions in new spending on health care, child care, dental care and pharmacare. "Look at pharmacare. Once that's in place, you don't get rid of that," Ms. Adomait said. While she's not necessarily opposed to deficits, they should at least be directed toward long-term growth, such as transportation infrastructure projects.

"There is a clear lesson here: how easy it is to get into debt, how difficult it is to get out of it and how important it is to stay out of it," said Perrin Beatty, president of the Canadian Chamber of Commerce, and a former federal cabinet minister under the Joe Clark, Brian Mulroney and Kim Campbell governments.

That's a lesson that seems to have been forgotten over the past decade, Mr. Beatty said.

In the fiscal year before the financial crisis began to unfold, every single province, in addition to the federal government, turned in a surplus, helping to stockpile financial ammunition that would soon be needed. "That helped, I think, ensure we were slower going into the recession, that it was shallower and that we got out of it earlier," Mr. Beatty said.

The Canadian economy was clearly in contraction for only three quarters, while the recession in other G7 countries lasted between four and six quarters. Most postcrisis analyses gave at least some credit for that to the federal government's aggressive intervention. The budget tabled in early 2009 included a stimulus package worth $47-billion over two years. That was on top of other measures, including the auto bailout, tens of billions in liquidity support for Canada's banks and the slashing of the Bank of Canada's key overnight lending rate from 4.5 per cent in late 2007 to near zero by the spring of 2009.

There was one big reason that stimulus helped stabilize the economy – the Canadian consumer. "The household sector could respond in a big way because [it] had the ability to take on debt," Mr. Porter said. In 2010 – the first full year of economic recovery, real consumer spending rose by 3.7 per cent, which alone contributed more than two percentage points to GDP growth that year, the economist said.

But that spending binge, combined with the swift rebound in the housing market, which largely continues to this day, has the average household now carrying a record level of debt. At more than 170 per cent of household income, credit market debt has been cited by the Bank of Canada as among the biggest risks to the domestic economy.

"I don't think we can count on the consumer to pull us out of the next downturn," Mr. Porter said.

Neither are many of the provinces on as sound a footing as a decade ago. Ontario's provincial debt has swelled, now at 38 per cent of GDP, compared with 26 per cent 10 years ago. At 46 per cent, Quebec's debt is still the highest in the country. And the crash in energy prices has left its mark on the fiscal position of much of Western Canada. Corporate debt, too, has crept up in the years since the Great Recession, as the era of cheap money has encouraged borrowing across the board.

Canada's Finance Minister Bill Morneau has been quick to point out that federal indebtedness is actually declining as a share of the domestic economy, despite the deficits. By that measure, Canada's debt load, at a little higher than 30 per cent of GDP, is the envy of the G7. "It provides us the opportunity to be resilient in case of a challenge," Mr. Morneau said in a speech in New York on March 9.

Federal debt ratios are indeed at a similar level today as what they were a decade ago, leaving plenty of fiscal room for stimulus spending when the business cycle eventually does take a negative turn.

But with so much debt built up elsewhere in the economy, it's far less clear that fiscal intervention would be as successful in stimulating aggregate demand as the last time around. That's reason enough for governments in Canada to exercise restraint now, to build up as much a buffer as possible for when the next big one hits, Mr. Beatty said.

"That's the advantage of getting your house in order in good times."