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Federal spending does fuel inflation, but it’s worth the hit: Desjardins

Click to play video: 'Government spending isn’t sole cause of Canada’s inflation woes, new report suggests' Government spending isn’t sole cause of Canada’s inflation woes, new report suggests
WATCH ABOVE: Decades-high inflation levels in Canada have turned up the political heat on the federal government in recent weeks. But as Anne Gaviola explains, a new report from Desjardins Economics sheds some light on who and what is to blame for rapidly rising cost of living – Jun 29, 2022

A new report calls on Ottawa to stick to its spending plans amid criticism that the federal government isn’t doing enough to combat surging inflation, while some experts suggest policymakers could crack down on price gouging without adding fuel to the fire.

Decades-high inflation levels in Canada have turned up the political heat on Ottawa in recent weeks.

A report from Scotiabank earlier this month charged the feds with abandoning their “joint responsibility” to tamp down inflation with the Bank of Canada and “doing nothing” to meaningfully reduce price pressures.

Read more: Freeland defends budget after Scotiabank accuses feds of ‘doing nothing’ on inflation

Those projections said if Ottawa trimmed its planned spending increases over the next few years, the Bank of Canada wouldn’t have to raise interest rates as high, potentially saving some economic pain in the months to come.

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While most economists point to the war in Ukraine and other supply constraints as keeping inflation persistently high through the first half of 2022, many also point to the role of higher government spending — as well as rock-bottom interest rates — through the pandemic as having stirred the inflationary environment in the first place.

Former Bank of Canada governor Stephen Poloz has justified emergency monetary and fiscal policies with the analogy that no one blames the firefighters for using too much water when they save the house.
Click to play video: 'Living with inflation' Living with inflation
Living with inflation – Jun 29, 2022

“Ultimately, that’s to some extent what we’re seeing now is that people are looking back and saying, well, it was probably more than what we needed, and that’s contributing to the current inflation,” Randall Bartlett, senior director of Canadian economics at Desjardins, said in an interview with Global News.

Bartlett authored a report released Thursday that attempts to respond to the criticisms about government spending and inflation.

Read more: Nearly 7 in 10 drivers worry they can’t afford gas as prices soar, poll finds

The report did not deny the role the Canadian government — and indeed, administrations around the world — played in fuelling today’s inflationary pressure amid a global effort to protect the economy from the steep downturns of the pandemic.

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But Bartlett and his colleagues write that while spending is part of what got the world into this mess, intense austerity is not necessarily the way out.

“While we don’t disagree that previous and ongoing federal spending is contributing to inflation, we believe it would be a mistake for the federal government to slash spending relative to its current fiscal plan,” the report read.

Desjardins noted that while spending as a share of Canada’s gross domestic product is expected to remain elevated in the years to come, pegged to inflation, the projected increases in federal spending should be roughly flat.

Deputy Prime Minister and Finance Minister Chrystia Freeland also defended the 2022 federal budget against such criticisms and said last week that she declined to announce new spending to help Canadians cope with inflation as a matter of prudence.

“We understand that fiscal policy has a role to play. That’s why we took this decision in April to pursue a path of … fiscal tightening,” she told reporters.

Click to play video: 'Freeland defends federal spending following Scotiabank report critical of Trudeau government' Freeland defends federal spending following Scotiabank report critical of Trudeau government
Freeland defends federal spending following Scotiabank report critical of Trudeau government – Jun 20, 2022

Current plan hits the right notes, experts say

Bartlett noted in the report that avoiding higher interest rates for the sake of reducing the impact on Canadians would skirt the vital role rate hikes play: taking steam out of Canada’s red-hot economy, particularly the housing market.

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Since the central bank embarked on its rate hike cycle a few months ago, cities across Canada have seen the rampant home price growth from the pandemic cool significantly as the costs of mortgages and borrowing rise.

“This is a correction that needs to happen to improve housing affordability and reduce vulnerabilities in the Canadian economy,” the report said.

Read more: How much will home prices drop as interest rates rise? Depends where you live

If the government did set out on a renewed austerity push, Bartlett wonders where it would find the cuts.

Reducing social spending geared towards the most vulnerable Canadians, for example, would be a mistake in his eyes. Programs set to see additional spending in the 2022 budget, such as a bump in Old Age Security payments and the Canada Child Benefit, can help lower-income households “bridge through this period of uncertainty and of economic difficulty,” he said.

“It’s those folks at the bottom end of the income distribution that are feeling the impacts of higher inflation most. And that’s a big part of the reason why we don’t think the federal government should engage in aggressive austerity at this point,” he said.

Crack down on corporate profits, price gouging, economists urge

Instead of cutting spending, there are some policies Ottawa could put in place that would help take some steam out of the economy, experts say.

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David MacDonald, senior economist at the Canada Centre for Policy Alternatives, told Global News that the recovery from COVID-19 has seen corporate profits among oil and gas producers and some grocery chains soar.

Wages, meanwhile, have not kept pace with inflation, suggesting businesses are seeing profits grow at the expense of the consumer.

“It may well be that the corporate sector just has more ability to raise prices much more quickly than workers are able to bid up their wages to try to keep pace with inflation,” MacDonald said. “So corporations have gotten out ahead of this, in essence.”

While the latest budget saw the introduction of a 1.5 per cent surtax targeting banks and life insurance companies, MacDonald argues that such a tax should be applied to all corporate profit in Canada, regardless of sector.

Proceeds from such a tax could fund programs supporting lower-income Canadians struggling with inflation, he suggests.

Armine Yalnizyan, economist and fellow at the Atkinson Institute, told Global News that the call to trim government spending is a “garbage argument” as the latest causes of inflation are supply-driven and global in nature.

Click to play video: 'Russian war in Ukraine will affect grocery shelves' Russian war in Ukraine will affect grocery shelves
Russian war in Ukraine will affect grocery shelves – Jun 29, 2022

She said Ottawa can take a bigger role in monitoring for “price gouging” in sectors where there’s little competition and where consumers shop for essentials.

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“Governments can and should be paying more attention to how prices are being set in sectors that don’t have a lot of competition. That would be groceries. That would be mining. That would be gas. Gasoline prices at the pump. There’s very few players in these markets,” she said.

Whether economists or consumers point fingers at the federal government or the Bank of Canada for driving up demand or not acting swiftly enough to tamp down on inflation, Yalnizyan said the harsh truth is that neither has as big a role to play in global price pressures as critics would argue.

“What can the federal government do? … What can the central banks do? There are some things they can do, but it is limited,” she says.

“We won’t get through this until the pandemic subsides and the war, the invasion of Ukraine by Russia, is converted to peace. It’s that simple and that complex.”

— with files from Global News’s Anne Gaviola

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