The federal deficit

So today marked a fairly important day for those following government budgets. The federal government released its fiscal monitor and provided an update to its Economic Outlook. The basics are that Ottawa is running deficits.

  • There will be a small $2.3B deficit for 2015-2016, of which is $300M for Alberta Stablization.
  • There will be a larger $18.4B deficit for 2016-17
  • And a deficit of $15.5B for 2017-18

There are a few things to note to understand these figures.

First, the deficit figures for 2016-17 and 2017-18 include $6B in contingency funds, meaning the real deficits are $12.4B and $9.5B. Not exactly sky is falling territory. However, the forecasts underlying these estimates are still fairly ambitious. For example, the outlook is based on oil prices that are at about $10 than the futures market is predicting and economic growth of 1.4%. To the extent that these and other assumptions prove false, we will be eating into the contingency.

Second, before people run amok blaming Liberal spending for this, these figures are essentially the status quo and what, generally, we would be seeing whomever won the election in October. In essence about 82% of the deficit figure is due to the contingency being increased from $3B to $6B and government revenues being lower than expected due to economic conditions. The remainder can be ‘blamed’ on spending. That is, the deficits are due to lower growth, lower oil prices, the exchange rate tanking, etc, not a spendthrift government. At least not yet.

Third, even with these deficits the debt-to-GDP ratio is not moving much, oscillating between 31%-32%. The Canadian federal government is in the enviable position of having fiscal room because we tackled the debt-to-GDP problem back in the 90s. Our ratio is very low compared to our OECD comparators whose federal debt-to-GDP ratios are mostly above 70%. We want to keep an eye on this ratio because it tells us if we expect an income stream to come in that offsets the borrowing we are doing.

So overall my inspection of this outlook is that the sky is not falling, it is not time to panic, and it is not wise to blame the Liberals for this. However, looking forward, I would say you really should know where your towel is (a HHGTTG reference for those unaware).

This is because we are looking at a federal government budget coming down on March 22 and it  is in that budget where we will see how the Liberal spending will add to this deficit. We are most likely to see that 2016-17 deficit nearly double to $30B (including contingency).

Is this a prudent thing to do? Well, I am not sure I understand this fixation on $0 deficits on a yearly basis. After all, fiscal policy is meant to play a stabilizer role. As said by Stephen Gordon, cutting back in bad times means that fiscal policy becomes a source of business cycle instability, which does not really help matters. Think of it this way, we want to smooth spending and taxes over time. We really don’t want taxes and spending to be a guessing game, being adjusted upwards and downwards year after year with no ability to predict one way other the other. So smoothing requires deficits and surpluses.

However, will spending play a stabilizer role in this downturn given the causes of it? Unless the spending is targeted specifically at those sectors/areas that are most vulnerable during this downturn, we are unlikely to see the positive stabilizing effects. How targeted the spending will be will be a matter to watch in the budget.

And will the spending just increase debt or will it also increase GDP? Think of it this way, if we borrow to invest in an asset that produces a stream of income that covers our borrowing costs (which are at an historical low and not going anywhere in the near future) then this is good. However, it can take time for an asset to produce that income so we might see an increase in the debt before we see the increase in income, meaning the ratio goes up before it goes down.

More importantly then is what is the plan to ensure that we see an increase in revenues in a reasonable time frame to ensure that the spending pays for itself and does not get us back into the debt and deficit cycle we were in throughout the 70s, 80s, and 90s. That, IMHO, is the more important thing to focus on. Making sure government spending makes sense and there is plan to avoid the dreaded cycle that our competitors are still dealing with.

I eagerly await the budget on March 22, but in the meantime, I will not be blaming anyone for this situation. It is what it is, and it is what it would be regardless of who was in power. March 22, however, ends that story.

UPDATE: I was alerted to this CPC video about the deficit announcement today and all I can say is that this is just political horseshit. The Liberals have not ‘spent’ $18.4B and it is disappointing to see the opposition not reading the economic outlook

Further, the deficit numbers are equally not the result of the CPCs cooking the books when they were in power before the election. Get a grip folks and life is better when you stick the facts and not the political spin.

 

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2 thoughts on “The federal deficit

  1. I suspect that refering to the Hitchhiker’s Guide to the Galaxy as “HHGTHG” won’t really help those who didn’t get the towel reference. Particularly that third “H.”

    Question – given the 1.4% growth assumption, how much spending growth would result in serious Debt-to-GDP deterioration (ie, how big of a deficit for how long before we start to look bad by OECD standards?)

  2. Thanks. The H Should have been a T. I blame fingers that move more slowly than my brain.

    There is not rule of the debt-to-GDP ratio and there is a good discussion of this by Scott Clark and Pete Devries here: http://www.theglobeandmail.com/report-on-business/rob-commentary/as-outlook-worsens-morneau-needs-to-find-his-fiscal-anchor-and-stick-to-it/article28841662/. There they show we are a far, far way from any comparator country.

    And we know the ratio grows if debt is growing relative to GDP. Since over the next few years, GDP is expected to grow around 2%, then any debt growth above that raises the ratio but as you can see if it will take a long time to get our ratio close to other countries.

    Also the borrowing costs matter. Since we can borrow at under 2% we can afford a higher ratio that we could when borrowing costs were say 8%.

    So it depends.

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