Deficit and Debt Phobia
We seem set to go into the next election – which could be in a matter ofÂ days -Â with both the Conservatives and Liberals firmly committed to bringing the federal Budget back into balance in a relatively short time frame, with no tax increases.Â There appears to be no sign of a break in the conventional wisdom that “exit strategies” fromÂ temporary fiscal stimulus should be pursued as a matter of urgency, and I fear that the NDP may well be pushed in the same direction.
That would leave us with remarkably little to talk about over the course of a campaign.Â If we are not prepared to countenance some combination of deficits and tax increases, then there can be no significant increase in public investments in services, social programs or in green infrastructure and jobs.Â To the contrary, the onlyÂ thing left to have an honest debate about would be where to cut spending (which won’t stop politicians invoking a fantasy world in which we return to strong growth while balancing budgets.)
Widespread Canadian debt phobia has its origins in the fiscal debates of the late 1980s and early 1990s when government debt and interest payments on the debt grew rapidly as a share of GDP. The majority of Canadians were convinced that we were about to hit a “debt wall”, and the Chretien – Martin governments slashed program spending to the bone to bring the federal Budget back into balance and then into surplus.Â For all of the Liberal claims to be a centrist or even progressive party, the reality is that they cut social programs and public services much more savagely than did the government of any other OECD country. Few have dared question the wisdom of balanced budgets since that time, and the current deficit has been reluctantly accepted only as an emergency measure.
What some understood in the late 1980s and early 1990s was that the growth of government debt was driven primarily by very high real interest rates.Â Â The dynamics ofÂ debt growth are driven most centrally by the relationship between interest rates and the economic growth rate. If high interest rates depress growth and add hugely to debt servicing costs, then the debt burden will soar… and that is precisely what happened.Â The Bank of Canada and its relentless pursuit of price stability via very high interest rates in the midst of a recession was the cause of the fiscal crisis, not government program spending. Â (See the book edited by Lars Osberg and Pierre Fortin, Unnecessary Debts, published by Lorimer in 1996 for a detailed analysis.)
Today, the basic elements of our fiscal situation are vastly different. The net financial liabilities of all levels of government combined in Canada are projected to be just 27% of GDP this year, compared to an OECD average of 51%. Our net debt is down hugely from the peak ofÂ 71% in 1995.Â (See OECD Economic Outlook Annex Table 3.) General government net debt servicing costs stand at an extraordinarily low and indeed almost trivial level of 0.2% of GDP, compare to an OECD average of 1.7%.Â The fact of the matter is that we are in great fiscal shape, and can well afford to borrow more and invest much more now that times are tough and public investment is needed to sustain jobs and set the stage for a more productive future economy.
Quite unlike the late 1980s and early 1990s, the stage is set for interest rates to be lower than rates of economic growth for some time.Â Long-term government bond rates are now in the range of 3-4%, or 1-2% in real terms.Â Even if we get back to only modest nominal GDP growth rates of 4-5% and interest rates rise a little,Â the gap between growth rates and interest rates means that we can run modest deficits without increasing the debt to GDP ratio at all.Â Increasing that ratio for a few years is not a big deal, certainly so long as the investments funded by borrowing are intelligently invested so as to improve longer term productivity growth and sustainability. It should ot be a huge challenge to think of investments – from child care and early learning, to renewable energy development and infrastructure – which yield a return far in excess of the low costs of borrowing.
But if deficits are judged beyond the pale from the outset, we can’t even have that debate.