There has been lots of hand wringing by fiscal conservatives over the failure of the 2018 federal budget to commit to eliminating the deficit by a fixed date. This, despite the fact that the federal deficit will be less than 0.5% of GDP and the ratio of debt to GDP (the debt burden) will fall to 28% the lowest level in the post war period. This fiscal record is the best in the G-7.
But this simply isn’t good enough, according to the Finance Minister’s critics. They believe the government should be running surpluses in order to have the fiscal flexibility to respond should a slowdown in the global economy occur. After all there hasn’t been one since 2009, so it is “inevitable” that one will happen soon.
Even though no one knows if this will happen, there are troubling signs emerging. Most important is the growing likelihood of a major fiscal crisis in the United States in the very near future. This looming fiscal crisis would seriously impact not just Canada, but the entire global economy. Moreover, given the political cycle in the U.S. there may be very little chance of avoiding it.
Sensible economic and fiscal policy (and just about every other policy) in the U.S. has gone into the proverbial “crapper”. We have an Administration that has no understanding of trade economics or trade policy; an Administration (and Congress) that has no understanding of tax policy or tax fairness or tax efficiency; and an Administration (and Congress) that has no understanding of fiscal and monetary policy. When it comes to fiscal policy the motto of both the Administration and Congress is “to put off far into the future what should be done to-day”.
The Congressional Budget Office (CBO) has just come out with is latest forecast of the Federal deficit, that includes the tax reduction bill and the budget spending bill. Its forecast can best be described as “scary” or more accurately as “horrifying”.
Here are some of the main conclusions:
- The deficit is expected to top $1 trillion in 2020 (up from current forecast of $804 billion for this fiscal year, and $665 billion forecast last year) despite healthy economic growth; in a decade, the deficit is expected to reach $1.5 trillion, with a cumulative deficit of $11.7 trillion over the decade.
- The national debt will reach more than $33 trillion in 2028 (up from $21 billion), or 96 percent of gross domestic product, the highest level since the immediate post war period.
- By 2028, interest payments will reach $915 billion, more than triple the interest costs last year.
- But the fiscal prospects are actually worse than that. If the temporary personal income tax cuts and spending increases are extended beyond their current expiry dates, which are highly likely, then the deficit would reach $2.1 trillion in 2028, and the debt would exceed the size of the U.S. economy.
It is pretty obvious that without major action to reduce spending and/or raise taxes the U.S government is heading into a runaway fiscal crisis that could seriously impact the global economy. Unfortunately, U.S. politicians have shown a complete unwillingness to make those decisions and this reluctance will be only worsened with the impending 2018 mid-term elections and the 2020 Presidential election.
The wildcard in all this is what might happen to interest rates in these circumstances. Rising deficits and debt could drive up interest rates, crowd out private sector investment, dampen the stock market, slow economic growth, and then raise the deficit even more. And the bond market is already showing its concerns. The yield on the U.S. 10-year treasury note touched a four-year high of 2.95 per cent on April 1, and analysts are predicting it could reach 3.95 per cent or even higher by year-end. On top of this the Fed will be continuing its policy of incrementally raising short-term interest rates.
Financial markets hate uncertainty and right now there is abundance of uncertainty in the U.S., with no relief in site. With the U. S. economy operating virtually at full employment what are the long-term prospects for inflation. Right now no one knows. What is the likelihood of a trade war? What are the prospects for NAFTA? Again no one knows and President Trump doesn’t seem to care. What are the prospects for escalation of hostilities in Syria? Again no one knows and everyone is waiting for an “irrational” President to make a decision. There are lots of questions and very few, if any, answers.
What does this all mean for Mr. Morneau? First, he should start acting as Finance Minister and not the “Minister of income equality”. He needs to develop a communication strategy that focuses on what he has been done to position the economy to deal with the possibility of a meltdown in the U.S. And the fact is he has done a lot, although he doesn’t seem to understand or appreciate that.
First, he has a sound fiscal framework (with a prudence reserve), which is more than capable of absorbing an economic slowdown. Second, fiscal policy is not primarily about short-term stabilization. It simply takes too long to implement. This was the case in 2008-09. Monetary policy is much better placed to respond to short-term problems. Fiscal policy needs to focus on critical medium and long-term issues. By doing so it can help sustain a strong economy. Most important, continuing to implement the infrastructure strategy is the best thing to do in the context of economic uncertainties. Perhaps it could be accelerated.
When confronted with global uncertainties the last thing the Finance Minister should do is adopt a policy of fiscal austerity. That would make any economic slowdown worse.
C. Scott Clark held a number of senior positions in the Canadian Government, including Deputy Minister of Finance from 1998-2001. He has a PhD in Economics from the University of California at Berkeley and is currently President of C. S. Clark Consulting.
From 1990 to 2005, Peter C. DeVries served as Director, Fiscal Policy Division, at the Department of Finance. In that capacity he was responsible for overall preparation of the federal budget. He is currently a consultant in fiscal policy and public management issues.
Their Blog is 3dpolicy.ca