In Mid-January, the Finance Minister, Chrystia Freeland, announced new budget consultations with Canadians to assist her in preparing her spring budget. According to Minister Freeland, the 2021 budget “will be among the most significant of our lifetime.”
We have no idea what a “significant” budget means and we doubt that the Finance Minister does as well. All finance ministers consider their budgets “significant” or “important”. We decided, therefore, to raise the bar and to replace “significant” with “credible,” even though we also know there is no agreement among economists as to what constitutes a “credible” budget.
To be credible, fiscal policy must be realistic. By that we mean fiscal policy should be based on sound analysis and a careful and balanced view of economic and fiscal prospects, challenges and risks.
Second, fiscal policy must be responsible. This means the government must be committed to establishing and maintaining a sustainable medium- or longer-term fiscal framework, one that supports long-run stable economic growth through control of the accumulation of public debt.
Third, fiscal policy must be prudent by including a reasonable amount of “insurance” to guard against forecast errors and the impact of unforeseen events and necessary policy actions.
Finally, fiscal policy must be transparent. This means providing full disclosure of analysis and information since, without this, independent experts will not be able to assess how realistic the economic and fiscal forecasts are. Without transparency, there can be no accountability.
With these criteria in mind, what will Minister Freeland have to do to make the 2021 budget among the most “credible” budgets in our lifetime? Up until now, most Canadians probably consider the 1995 budget to be the most credible budget in that it satisfied all four criteria.
Given the current context of the COVI-19 crisis, and the necessary shutdown of the economy, the Minister has some very tough challenges ahead in planning her budget. A critical ingredient of any economic recovery will be consumer and investor confidence. Notwithstanding the high levels of consumer and corporate liquidity, the amount and timing of consumer and investor spending is uncertain. A successful vaccine rollout is a precondition to any economic recovery and by extension a credible budget.
The Minister’s Mandate letter (January 15, 2021) sums up her short and long-term budget challenges.
Preserve Canada’s fiscal advantage and continue to be guided by values of sustainability and prudence by presenting a plan to regrow the economy and presenting a new fiscal anchor to guide this work. You will use whatever fiscal firepower is needed in the short term to support people and businesses during the pandemic, and will keep supporting the economy with emergency measures until the economy improves. Doing so, you will avoid creating new permanent spending. You will also lead the creation of a resiliency agenda for Canada’s longer-term post-pandemic economic recovery, including actions to transition to a greener, more inclusive and more prosperous economy. You will also review our debt management strategy.
In addition to all that the Minister must:
“Foster a professional and respectful relationship with journalists to ensure that Canadians have the information they need…”
Last December, the Minister presented her Fall Economic Statement 2020 (Update) to formally start the process of budget consultations. In developing the economic assumptions underlying the Update, the Minister met with private sector economists. She met again with private sector economists in January to discuss how much stimulus spending might be required and for how long. She also needs their views to ensure the credibility of the economic assumptions used in developing her upcoming budget. Here the Department of Finance should present much more information on the details of the economic and fiscal forecasts, as is currently done by a number of provincial governments.
According to her Mandate letter, she is to use whatever “fiscal firepower is needed” and to continue doing so “until the economy improves”. In doing so, she is to avoid creating “new permanent spending” programs. In her November Update, the Finance Minister committed to $70 to $100 billion of stimulus spending over three years, although the funds were not explicitly included in the Update’s fiscal projections. She was unable to say what would be in the stimulus spending and little is known of their recovery plan even today.
Some have argued that the employment rate should be used as a “fiscal guardrail” in determining the amount and duration of the stimulus spending. The employment rate measures the number of people working in relation to the working age population. To put that in context for the economic recovery, the employment rate in 2008 was 62.3% and in 2019 it was 61.9%. In January 2021, it had fallen to 58.6%. This decline in the employment rate has affected working age women much more than men.
To restore the employment rate to its 2019 level in four years would require the creation of an additional 1.6 million jobs per year. It would take annual economic growth in the 4 to 5 percent range to generate that many jobs in 2023-24. This is highly unlikely. Private sector forecasters and the Bank of Canada are forecasting growth of around 4 percent for this year and next year but only 2.5 percent in 2022. The Minister should be very careful in setting employment targets that will be difficult to achieve.
Having said that, we believe the Minister should err on the side of “too much” stimulus rather than “too little”. This may require extending the duration of the stimulus spending from three to four years and possibly front-end loading the spending. The composition of the stimulus spending is just as important as the amount of spending. In all likelihood, the size of the stimulus package will be the main focus of criticism in the budget.
Critics of large stimulus will argue that, with the excessive liquidity already in the economy, this could lead to an outbreak of inflation. This argument against large stimulus was successfully used after the 2008-09 financial recession and resulted in a decade of economic underperformance and a constant risk of deflation, not inflation. Should signs of inflationary expectations begin to emerge, then the Bank of Canada has more than enough policy tools to deal with it.
In our view, the most important group that will determine fiscal credibility are financial markets. The Fitch rating agency downgraded Canadian debt last July and indicated at the time that they would consider a further downgrade depending on the Minister’s budget. Interest rates may be low now but financial markets can still impose brutal risk premiums on borrowers.
Fortunately, unlike the early 1990s, there is no immediate fiscal crisis but there is a major fiscal problem. The Minister is now confronted with a deficit of just under $400 billion for 2020-21, compared with just under $40 billion in 2019-20. The debt ratio is now just over 50 per cent of GDP compared to just over 30 percent in 2019-20.
The Minister will have to set out a fiscal strategy for reducing the deficit to an “acceptable level” and reducing the debt burden over a “reasonable” time period. This does not mean adopting a policy of fiscal austerity, as was the case after the 2008-2009 financial recession. Growth through austerity was a failed strategy after 2008-2009 in Canada and in the EURO area.
Nevertheless, financial markets will want to see a clear commitment to fiscal prudence and a credible fiscal anchor once the recovery has matured. Unfortunately for the Minister, experience in other countries and past experience in Canada provide little help in choosing a fiscal anchor. A credible fiscal anchor depends entirely on the willingness of a government to make tough political decisions. Perhaps this is why fiscal anchors have rarely succeeded.
The Minister has been meeting “virtually” with other major stakeholders and the House of Commons Standing Committee on Finance has released its pre-budget consultation report to the Minister. The Minister has also been appearing on a number of media outlets.
In January, the Minister released an on-line questionnaire aimed at finding out the budget priorities of Canadians. Unfortunately, Canadians don’t appear to be very interested in the budget right now. Their primary interest is when they will get vaccinated which, given the way things are going, is not likely to be until after the budget.
Given the Minister’s skills as a financial journalist, she might want to consider writing policy commentaries in international and domestic media. She needs to do something to generate some interest in her budget and to get factual information into the public domain.
Last fall, the Government was telegraphing that after the economic recovery, which could take three to four years, they were prepared to run on-going structural deficits in order to finance the “investments” critical for strengthening competitiveness and long-run potential economic growth. After all, long-term interest rates are currently very low and the Government would be derelict not to take advantage of them.
Since then, there has been a shortage of new information regarding the government’s long-term strategy. Investments in the “green” economy were announced last year. The only new information was the Prime Minister’s announcement of $14.9 billion on public transit funding over eight years, beginning in 2026-27. This appears to be an extension of the existing infrastructure program already in the fiscal plan and which for years has been seriously underspent.
Despite lots of rhetoric there has been very little information on what the government is seriously thinking on health care, pharmacare, childcare, and long-term home care, all areas of provincial responsibility. As an aside, if the government really wants to do something for economic growth, perhaps it should consider a commitment to reform the income tax system or actually getting rid of internal trade barriers. Free trade within Canada would have a significant impact on GDP.
There is a basic but very important “rule” in budget planning that on budget day there should be no surprises. This has been true for all budgets for the last forty years, some with great success and others with little success. The government needs to d0 a lot more to avoid breaking the ‘no surprises’ rule.
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