Fiscal Chic: Deficits are the New Black

Or would that be red? Anyway, our “left-leaning”, Keynesian thinking is quickly becoming the new centre. Fresh from endorsing PM Harper’s re-election, the Globe and Mail’s editorial page says:

The scarred memories of $39-billion deficits are still fresh in the minds of many Canadians. We have been conditioned to demand that government stay out of deficit spending. Under all but extreme circumstances, that is the best policy. But it would be far more devastating to the economy if, to avoid a deficit, the government pulled the plug on many of the programs that hefty surpluses in recent years permitted.

Canada achieved a great deal under the belt-tightening by Liberal governments of the 1990s, and the Conservatives have adhered to the regimen established by Paul Martin when he was finance minister. The federal debt-to-GDP ratio dropped from 68.4 per cent in 1995-96 to 32.3 per cent in 2006-07. Canada’s total government net debt-to-GDP ratio has been the lowest in the G7 since 2004. Ottawa was predicting last year that the country would eliminate its net debt by 2021.

This is obviously desirable. But adhering rigidly to debt reduction targets during an economic crisis is unwise policy and unwise politics. Surely one of the reasons for the spending cuts of the 1990s and the pay down of the debt was to allow flexibility in the event that the economy actually did run into trouble. It’s Canada’s record of fiscal prudence that makes running deficits a temporary option.

Which makes one wonder why they endorsed Harper, since he is the most likely to cut spending to keep the budget balanced (thankfully, a minority should weaken his resolve). This is pretty much what I said back in January in a Technical Paper for the Alternative Federal Budget:

Having saved for a rainy day, the federal government should be prepared to use the umbrella of deficit-spending if need be. Canada’s debt-to-GDP ratio fell from 68% in 1996/97 to 32% in 2006/07. The bulk of this reduction is due to economic growth, rather than surpluses. Nonetheless, the government has substantial room to run a deficit if it so chooses. Compared to other G7 countries, Canada’s net liabilities are the lowest by a fair margin, with other countries running deficits in recent years compared to Canada’s surpluses.

The central question is what to do. The PEF’s Open Letter from Canadian Economists argued:

The spreading downturn in both the financial and the real sides of the economy is likely to undermine spending and employment levels in many regions and sectors of Canada’s economy.  Income support measures, employment insurance in particular, should be strengthened.  In addition, public infrastructure projects, including those aimed at reducing Canada’s greenhouse gas emissions and expanding affordable housing, should be ramped up to maintain employment and production (as private-sector activity declines).

The federal budget is narrowly balanced, and may slip into deficit (especially if real GDP begins to decline).  The current government has pledged to prevent such a deficit at all costs, and this will mean significant cuts to public spending as the budget balance deteriorates.  But that course of action would worsen the economic downturn and job losses.  It is far better to maintain public programs to support employment and incomes, even at the cost of a cyclical deficit.

This is not a massive insight into Keynesian economics, but it makes me happy when I see Paul Krugman, the newly crowned (OK, it is not really a Nobel*) Laureate say essentially the same thing:

On the other hand, there’s a lot the federal government can do for the economy. It can provide extended benefits to the unemployed, which will both help distressed families cope and put money in the hands of people likely to spend it. It can provide emergency aid to state and local governments, so that they aren’t forced into steep spending cuts that both degrade public services and destroy jobs. It can buy up mortgages (but not at face value, as John McCain has proposed) and restructure the terms to help families stay in their homes.

And this is also a good time to engage in some serious infrastructure spending, which the country badly needs in any case. The usual argument against public works as economic stimulus is that they take too long: by the time you get around to repairing that bridge and upgrading that rail line, the slump is over and the stimulus isn’t needed. Well, that argument has no force now, since the chances that this slump will be over anytime soon are virtually nil. So let’s get those projects rolling.

It is easy to feel marginalized as a progressive economist, especially when the banks and Ottawa insider think tanks are now dominating the news cycle for stuff we have been saying for months. But it is worth noting that we are in good company, and I think most of the time we get it right when it comes to good economic analysis and policy.

Relentlessly Progressive Economics: Tomorrow’s conventional wisdom, today.

[*Technically, this is the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, because Nobel did not actually endow a prize in economics back in 1901; the economics prize was added in 1968.]

5 comments

  • Marc, has the CCPA Alternative Budget ever suggested less fiscal stimulus than what the feds of the day were proposing?

  • Stephen,

    Let’s put it this way: back in the early 1990s federal expenditures averaged about 17% of GDP. In recent years they have been about 13% of GDP, after hitting a trough of 12 % around 2000/01.

    Have we been arguing against this trend since our first Alternative Federal Budget was issued in 1995 (I was actually working for the federal government back then)? Yes, and since our budgetary recommendations are not generally implemented, consistently so.

  • No, that’s not what I meant. I have no problem with the notion that spending should have kept up with GDP growth once the deficit had been dealt with (as long as the spending is on worthy projects, of course).

    But the argument in favour of increased spending can’t always be based on the argument that we’re about to go into recession. Because if you make the same claim year after year, people are going to start to tune you out.

  • Stephen, you say ‘once the deficit had been dealt with’, but when governments spend vast amounts of money paying interest to private bankers, as they did in the ’80’s, and continuing, along with corporate tax cuts, and only paltry amounts on the actual social programs that the electorate expects, then, yes, there is going to be a consistent call for increased spending for good projects.

    Federal governments in the past two decades have been disingenuous about their respect for other people’s money. They’ve been taking from Peter (and Jane) to pay Paul.

    It’s the bigger picture we’re needing to correct, and all hands on deck…

  • Gordon writes:

    “But the argument in favour of increased spending can’t always be based on the argument that we’re about to go into recession. Because if you make the same claim year after year, people are going to start to tune you out.”

    Kinda like the argument for corporate tax cuts cuts. Well no because CIT cuts are made in good and bad times. Funny though, Gordon and his ilk never seem to tune them out…in fact they militantly broadcast in favour of them day after day; month after month; season after season; year after year; decade in and decade out.

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