Deficits. Boo!

Deficits.

There. I said it.

Are you afraid?

You shouldn’t be.

If, as I suggested in my previous post, monetary policy is proving ineffective and if fiscal policy needs to be a big part of the solution, then we must consider what for many has become the unthinkable.

We must revisit our fear of deficits, that word — that state of fiscal affairs — that excites such fear in our political class and in a good too many economists.

Deficits. The word is powerful enough to compel our entire political class from left to right to publicly confess their faith and allegiance on TV no less (witness the French and English leadership debates) while trying to one-up competitors in their piety (who knew the Bloc proposed a balanced-budget rule? Surely this was another dastardly attempt of theirs to destroy our country by hook or by crook).

Deficits.  That word — that state of fiscal affairs — that is arbitrary measured over a calendar year (why not every month? or every week? or every 5 years?).  Remember the excited headlines a few short months back when the federal budget moved into deficit and oh how we rejoiced when it moved back to surplus a while later. Oh exalted surplus. Do not leave us, deity of accounting rules. What nonsense.

Deficits. That word that is the product of an accrual accounting system which the vast majority of economists, and even its practitioners, only dimly understand.  To cite but one example:  surpluses do not “automatically pay down the debt” and deficits do not “automatically add more debt.”  The only thing they do, with the uncanny reliability inherent in an accounting identity, is alter the accumulated deficit.

Deficits. That word that has acquired a veneer of taboo in our poor frightened little country despite overwhelming real-world evidence that sovereign nations like ours, with their own currency unit, have nothing to fear but their own increasingly perverse fear.

It is time, as the PEF open-letter suggests, to embrace this maligned word, to challenge the taboo, to stop reciting the silly narrative that heaps praise on Canada’s turn to “fiscal conservatism”  — one that as Lars Osberg has rightly noted, was made on the backs of low-income Canadians — and ignores  basic economic wisdom not to mention justice.

We need spending, now, not tomorrow, on things we need, now, not tomorrow: roads, bridges, water treatment plants, sewers, parks, schools, hospitals, teachers, doctors, nurses, and public infrastructure more generally.

We need to seriously consider, as Warren Mosler suggests for the United States, an immediate reduction in taxes that put money directly in the pockets of people who are going to spend it — the lower and middle income Canadians that are going to find it increasingly difficult to make their mortgage payments and pay for rising food costs.

And to get there, we need a new dialogue. One that does not run away in fear from economic responsibility but proudly, and rightly, states that a deficit is necessary now, not tomorrow.

6 comments

  • I don’t mind governments borrowing money for things we need. My problem with Harper is that his deficits are made from tax cuts for the rich and bullshit “green” programs.

  • For those few readers of the PEF who do not carefully read the Toronto Star everyday (that would include me) below is an Op Ed of mine they published today on the topic of ‘deficits’ related to the above post:

    Politicians refuse to admit that deficits are inevitable
    TheStar.com – Federal Election – Politicians refuse to admit that deficits are inevitable

    It is time they explained how they will maintain fiscal discipline in an economic downturn

    October 09, 2008
    Michael Mendelson

    The American economy is headed into a significant downturn. Although the length and depth of the economic malaise is unknown, it will not be short and shallow. While the earlier savings-and-loan debacle and the dot.com collapse were confined to narrow segments of the economy, the U.S. financial crisis currently dominating headlines is symptomatic of a deeper underlying debt crisis.

    America has been borrowing about 5 per cent of its GDP each year, through both government and consumers. As the debt mountain has climbed ever higher, the quality of debt (i.e., the ability of the borrower to pay interest and eventually repay the debt) has necessarily deteriorated. The mountain is now collapsing under the weight of low-quality debt and is carrying along with it the financial institutions that built rickety structures along its slopes. But even if these institutions survive with government bailouts, the U.S. economy still has to wring out about 5 per cent of consumption.

    As the U.S. economy goes, so goes the rest of the world. Europe is in no way exempt as is already evident. Developing countries such as China and India may recover more rapidly and even continue to grow, albeit less rapidly. In the short run, though, they too rely on exports for a huge portion of their economy. Turning around their economies to rely upon internal demand instead of exports will take time. But of all countries, Canada is least exempt because our economy is most deeply integrated with that of the U.S.

    Canada’s low level of public debt and its better-regulated banking sector mean that we will probably not suffer a collapse of our own financial institutions (although the U.S. credit collapse will squeeze Canada, too). However, we are predominantly a trading nation and more than 80 per cent of our trade is with the U.S. Consequently, all of our export-oriented manufacturing industry will be hit extremely hard.

    Even the robust economies of Western Canada will be affected. Although we usually focus on the price of oil, natural gas is the big export from the West. The natural gas market is confined almost fully to North America and will follow the North American economies downward.

    With declining world demand, other commodity prices are likely to continue falling, only to stabilize for a time at lower levels. In addition, many of our businesses are branches of U.S. companies and will be part of those companies’ adjustment strategies. Overall, Canada could suffer as much as – if not more than – the U.S.

    We can hope that by some enormous stroke of good luck this dire scenario will not be realized. But we need to plan for the worst, while hoping for the best. Even a partial realization of this scenario implies that Canada’s governments will face huge revenue losses and climbing program costs – in other words, deficits.

    Our political leaders are dealing with likely future deficits mainly by squeezing their eyes tightly shut and repeating the mantra that there will be no deficits. Pressed hard to reveal their strategy for dealing with deficits, they mutter darkly that they will “never permit a deficit” without saying exactly how this magic will occur.

    But there is nothing secret about deficit reduction. There are only two ways to eliminate a deficit: Cut spending or increase taxes. Yet either route would be foolish in the midst of a recession. Either route takes money out of the economy and will increase unemployment and misery.

    Employment Insurance is a good example. As unemployment goes up, Employment Insurance costs increase. The existing law requires that Employment Insurance balance its accounts over the space of a few years, so there are two choices: Premiums must increase or benefits must be cut. Increasing premiums in a recession will push more companies under water and result in even higher unemployment. Cutting benefits just when increasing numbers of Canadians most need them will raise howls of protest and reduce consumer demand in an economy already suffering from diminished demand, again increasing unemployment. Yet leaving premiums and benefits unchanged will result in a deficit in the EI accounts. What will governments do?

    Governments, both in Ottawa and in the provinces, will have deficits. So far, governments have resolutely refused to make public their plans if, in fact, they have any plans and, perhaps as important, have failed to prepare the media and the public for the inescapable fiscal realities. The result will be fiscal mayhem exactly when we can least afford it. Responses will be uncoordinated and sometimes contradictory.

    If we take a hard-headed unemotional look at the numbers, Canada can easily afford a few years of deficit financing. We now have the lowest level of debt as a percentage of GDP among the G7 countries and the third-lowest level of taxation, next only to Japan and the U.S. Tax levels in the United States will eventually be higher than those in Canada when it starts to pay for its public debts.

    The reward for Canada’s fiscal restraint in the fat years is to have earned some fiscal room in the lean years. The problem with deficits is not the mere existence of a financial shortfall. The real problems occur if deficits are too large, if they are built into government budgets as a structural element rather than a cyclical response to temporary conditions, and if they are uncoordinated with economic and monetary policy as a whole.

    The challenge Canada faces is not the deficit as such: It is maintaining fiscal discipline even with deficits. Yet, if the line of balanced budgets is crossed, how do we stop ourselves from going a little further? Once the tap is turned on, how do governments resist turning it just a little further to get some political payback from happy recipients of government largesse?

    Governments can maintain fiscal discipline by setting clear, sensible guidelines that are possible to maintain even during an economic downturn. Lest this approach be considered pie-in-the-sky, remember there are precedents. The adoption of “fiscal rules,” which permit deficits within a disciplined framework, has been incorporated into legislation in some European countries, such as Germany and the U.K.

    Canadian fiscal rules should require that deficits go only toward maintaining programs and one-time expenses, such as infrastructure and economic adjustment. Specific budgetary targets could be set by keeping government expenditures within the long-run trend of GDP. Anti-cyclical spending to “fight the recession” should go only for infrastructure investment that will create lasting benefits for many years and lay the foundation for economic recovery.

    Canada is headed into stormy economic times. Our governments seem determined to navigate these waters with their eyes closed. We need instead to face reality right now and start realistic planning for the seemingly inevitable moment when the fiscal dam bursts.

    Michael Mendelson is senior scholar at the Caledon Institute of Social Policy and Ontario’s former assistant deputy minister of finance.

  • Great article, just one small point.

    I know the EI surplus that has built up over the past several years has been spent on other things, however this exasperates the problem of public hysteria over deficits and makes the requisite economic culture change towards a friendly interface with deficits more difficult.

    So I might have added a comment or two on the EI fiasco and the missing 56 Billion.

    I know there are some EI projections done given different scenarios. However the main point is the friendly attitude that we must remind the public on deficits. It is the way the capitalist economic beast has evolved and we are allowed, like other developed economies to run a deficit during lean times.

    I wouldn’t run a election platform on it, but I am sure once the election is completed we will be hearing a lot more of deficits and such. There is no mention of it currently but in behind all those election promises, given the economic transformations taht we have been loudly suggesting in the PEF, deficits are one of the new tools that will be required. THat is a given and people must get over it and allow policy makers to plan and implement a move on to better times ahead.

    As you mention there is a danger that without access to all these tools we will Hoover ourselves right into a systemic vicious cycle.

    I for one have never been to Hooverville and I had hoped I could avoid that landscape.

    paul

  • There has been a lot of confusion about the EI suplus. Here is my story on it, which explains why I did not mention it.

    The EI surplus is gone: it financed almost all of the debt reduction over the last several years. There never was a reserve fund or anything like that established for EI. The EI surplus was at best a notional account and at most an accounting concept. The EI surplus or deficit has been reported as part of the consolidated fiscal position of the government of Canada. In short, there is no pool of surplus funds waiting to be used.

    I am not sure how the accounting rules will work in the current EI legislation. In any case any EI deficit will have to be financed by the government from the consolidated revenue fund and I suspect that the deficit will be reported as part of the consolidated fiscal position of the government even if the EI fund issues ‘IOU’s’ to the government of Canada.

    So, there really is no separate EI fund. For a variety of reasons I am not in favour of a separate EI fund, and if we were to have one, now would definitely not be the time to start!

  • There may not have been an official accounts but the legislation determining amounts to be charged as premiums to employers and employees are highly skewed in terms of the health of the economy.

    As I stated this account in turn would have been a lot easier to take money from without accruing a deficit to the overall economy. I am not suggesting that should not have used the monies for other purposes, but I am suggesting that in formal terms some notion of accounting should be in place. Of course I believe that when the payouts were like they once were, i.e. they were a true UI based program and not some selective, ad hoc based subsidy to employers, governement legislators would never how planned on such huge surpluses. However with the transformation of UI to EI, it has resulted in something that pays out little and took in a lot. I worked on that file for a couple of years and the sub programs that ran off that fund were astounding. Yet the fall off in pay outs to traditional unemployed individuals dropped both in claimants expected given a priori data and per claimant payout- it was obtusely obscenely despicable. (putting it mildly)

    I digress.

    I am not sure which would be a better accountability system. Moving towards a true insurance based system has been favoured by the CLC so I am assuming that would entail separate books. It is a rich database for research and mining, if only I could get back onto that file the gems one could find.

    I recommend it for anyone looking into employment policy research, it is a rich fairly clean, mostly straight forward research base. The government should do a lot more research on that file.

    Paul

  • I think the deficit issue is a false bogeyman. There are right-wingers who bring in deficits amid tax cuts, like in the US. There are left-wingers who bring in surpluses while expanding services, like Tommy Douglas. In my books a fiscal conservative wants to lower taxes and spending, and a fiscal progressive wants to expand taxes and spending, and this is the key distinction between a right-winger and a left-winger. Everyone else is just trying to con us.

    A person’s loyalty to, or dismissal of, deficit-phobia is a sideshow arising from an early-1990’s PR campaign to pass off spending cuts as prudence. Let’s shake it off and move on with our lives. It’s been far too long since Martin slashed transfer payments to cling to this temporary political debate.

    A major problem is that business conservatives have this frame where, like a good business person, you should run a surplus at all times or your business should close shop. And the progressives have to fend off those in their own ranks who think we should run deficits in good times and bad, and eventually declare they we not pay it back, and the collapse of capitalism is good for us all anyway, just don’t tell anyone ahead of time. At least that’s what it sounds like to me.

    Let’s just stick to running surpluses in good times and deficits in bad, include some automatic stabilizers in our (expanded) public services, and keep a backlog of pre-approved infrastructure programs ready to roll when GNP growth dips for two quarters. Seems pretty basic to me.

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