Canada's Deficit

The Outcome of Government Spending Post-Pandemic

The current economic slump caused by the coronavirus has seen governments issuing enormous amounts of debt. In Canada, the deficit is projected to hit $343.2 billion this year, with stimulus packages on par with World War II spending. According to Gavyn Davies, Chairman of Fulcrum Asset Management, this estimate would see the ratio of public debt to GDP jump from approximately 10% to 20% year over year.

Defendants of the enormous deficit argue that there is no better time to borrow. Ian McGugan, business reporter at the Globe and Mail and founding editor at MoneySense magazine, explains that it makes sense to borrow at a 0.7% rate to support an economy capable of growing 3% or more in the near future. The idea is that once growth returns to normal, the economies of industrialized countries such as Canada should expand substantially faster than the interest of their debt.

Alternative macroeconomic theories have been rising in popularity

This school of thought has led to a resurgence in the widely controversial Modern Monetary Theory (MMT). MMT is an emerging macroeconomic framework that states that nations, such as the United States and Canada, who are in control of their own currency are not constrained by revenues or GDP when it comes to federal spending.

Governments possess the ability to spend freely and print more money to pay interest. MMT rejects a core principle of traditional economics by suggesting fiscal policy should direct economic activity. While the number of MMT proponents is on the uptick, the theory presents many challenges that make it a less-than-ideal solution to the world’s current economic challenges.

Canada’s increasing debt is cause for alarm

Debt is increasing at an exuberant rate. In 2019, the IMF issued a warning that up to $19 trillion of business debt could be vulnerable if there were to be material slowdown to the economy.  In Canada, we have seen an enormous deficit, similar to what is suggested by the MMT school of thought. Throughout the pandemic, the Trudeau government has accumulated more debt than the previous 22 prime ministers combined.

This amount of government spending is dangerous as it is difficult for governments to determine if they are spending correctly. The economy is also affected by expectations surrounding inflation and there is no guarantee that the large payments will actually benefit Canadians. In this period of post-pandemic recovery, it is essential that Canada investigates the consequences of issuing significant debt.

It is difficult for governments to determine if they are spending the right amount of money using MMT

MMT argues that no matter how expensive an outpouring of government aid may seem in the present, it is much cheaper than the possibility of a depression in the future.

However, it is challenging to estimate exactly how much debt a country should take on, and as a result, the significant amounts of debt associated with MMT have the potential to affect future economic policy in a way that may present longer-term risks.

In the case of Canada’s COVID-19 response, government transfers to households increased by $119 billion in 2020 compared to the year prior. This is in comparison to a decline of only $6 billion in regular income over the last year. This has deteriorated Canada’s capacity to deliver new programs and services, meaning that future tax increases are a near certainty. Hence, MMT works in theory only if economic activity is controlled by politicians who spend appropriately, which is often not the case. In practice, the Canadian government has historically invested in inefficient projects—which creates more harm than good when there is already a significant deficit.

Expectations surrounding inflation discourages corporate investment and impacts Canadian investors

Economists speculate that the significant amount of debt issued is likely to create inflation and erode asset prices in the long term. In June, Consumer Price Indexes increased 5.4% from the year earlier, the biggest monthly increase since August 2008. Although the sentiment amongst professional investors is that this is temporary, the large hikes in prices may lead to a negative income for consumers, impacting the real income of Canadian investors. According to RBC Global Asset Management, there are four factors that are contributing to a rise in inflation:

1) Central banks around the world have cut interest rates and purchased bonds to fuel their respective economies,

2) Significant fiscal stimulus responses by governments has greatly increased the sum of cash in circulation,

3) The rollout of vaccines through the summer and fall that will result in increased economic activity, and

4) The statements issued by central banks disclose that they will allow inflation to run hotter than usual before raising interest rates.

Investors holding government bonds have seen their purchasing power reduced. This is on account of inflation driving up yields, causing bond prices to drop. Furthermore, the payments received from fixed income investments have reduced purchasing power. This leaves investors with the question of whether the returns they receive from their investment will outpace the rate at which their purchasing power will decline. As a result, the rising inflation rates created by the application of MMT policies within our government’s fiscal planning will result in decreased corporate investment, a challenge that Canada is already facing.

Distributing large payments to Canadians will not necessarily stimulate the economy

Relief packages distributed by the Trudeau government have amounted to more than $5 trillion. Canada has seen the biggest increase in national debt amongst advanced economies, with debt rising by 50 percentage points to amount to 353% of GDP. Despite this significant infusion, the Canadian economy shrank by 5.4%, underperforming the United States for the third year in a row.

This proves the point made by many opponents of MMT, such as economist Michael Roberts, who has pointed out that MMT does not address the cyclical slumps that occur within an economy. He claims that printing more money so that governments can spend more does not create more value unless more labour power is used by the increase in capital as a result.

This has not been the case in Canada, where Canadians have been saving, rather than spending, the money distributed by the government, with $20 CAD in government transfers being paid out for every dollar of income lost. Thus, while the principles of MMT may work in theory, they may not be successful given the realities of the economic cycle and consumer behaviour.

While MMT proposes an idea that solves Canada’s problems in theory, the reality of our current spending paints a much bleaker future. Expectations surrounding inflation discourages corporate investment while not necessarily benefiting the economy whatsoever. Furthermore, it is difficult to apply the principles of MMT effectively with a government that is inefficient.  Thus, although piling on debt was a short-term solution to pandemic related troubles, in the period of post-pandemic recovery, the Canadian government must investigate the consequences of our surmounting national debt.