$35 billion deficit sustainable, bank report argues; others urge caution

Minister of Finance Bill Morneau.
Minister of Finance Bill Morneau. THE CANADIAN PRESS/Sean Kilpatrick

At the high end, running federal deficits of up to $35 billion for a short period of a few years is manageable, argues a report issued by the National Bank of Canada earlier this month.

“When it comes right down to it, running deficits of $30-35 billion for a few years isn’t going to erode Ottawa’s long-term fiscal sustainability,” wrote senior bank official Warren Lovely. “Given past success in wrestling the federal debt-to-GDP ratio down to size, and given rock bottom interest rates … Canada needs to ask itself: do we need the federal debt burden to keep falling forever and ever until the end of time? Probably not.”

“The Canadian economy needs some stimulus, and given the past efforts to reduce the debt-to-GDP ratio, now we can afford a deficit for some time,” Marc Pinsonneault, the bank’s chief economist, told Global News today.

Taking into account the weakening economy and a promised stimulus, the report predicts a cumulative deficit of $90 billion over the four-year life of the government. (During the campaign the Liberals promised to keep deficits below $10 billion; on Monday Finance Minister Bill Morneau predicted an $18.4-billion deficit.)

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The budget will be tabled on March 22.

Canada’s debt-to GDP ratio is much healthier than in many other Western countries

Debt-to-GDP ratio, 2014

Others are more reserved.

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“There are plenty of reasons why Ottawa does not have a free hand to spend on every priority, and must maintain discipline,” cautions a recent report by Bank of Montreal economists Douglas Porter and Robert Kavcic.

While agreeing that “Ottawa can clearly afford a moderate fiscal boost, without doing lasting damage to the long-term debt outlook,” Porter and Kavcic argue for caution in deficit spending.

READ MORE: Alberta may qualify for up to $250M in federal cash, says Morneau

Part of the case for caution comes from the provinces’ worsening fiscal position, which, they say, may create long-term liabilities for the federal government.  Combined provincial debt, they point out, is on track to exceed federal debt. Only two provinces have balanced budgets, and most provinces have seen their credit ratings worsen since 2008.

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“Looking ahead, the provincial challenge is only going to stiffen, with (revenue) growth slowing and spending pressures building as populations age.”

(Some observers fear if a province was nearing default, Ottawa would be forced into an unappealing choice between bailing it out or letting it fail, damaging public-sector credit ratings across the country. )

Also, global prices for commodities like oil may not recover, at least in the short term – we shouldn’t take on debt now, hoping to pay it off when oil prices rise again.

“Canada is facing a structural shift from the commodity shock, and that’s not something that can be quickly countered or fully mitigated by a big fiscal boost.”

Because of lower interest rates, we don’t need to be concerned about a rerun of the debt crisis of the 1980s and 1990s, Pinsonneault says.

At the time, higher interest rates led to a dangerous self-reinforcing cycle in which Ottawa borrowed money to pay interest, then had to borrow more money at high rates to pay that interest, and so forth.

“Part of the deficit was to pay for the interest on the debt. You make large deficits, and you have more debt, and you have high interest payments to make, so you have higher deficits to pay for large interest payments, and so on. We were in that spiral at that time. We’re not, at the moment, near that spiral situation.”

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“We’re not in that situation – not at all. If it were not for the drop in oil prices, we would be contemplating budget surpluses.”

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