Ottawa's budget built with a cushion to produce a soft landing

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Ottawa's shiny new $29.4-billion budget deficit is a lesson in the contradictory forces of hopes and fears. When you dig into the economic assumptions built into that shortfall, you see a government that is simultaneously taking a bold leap of faith and giving itself a substantial safety net.

In turning Canada's approach to fiscal management on its ear, the new Trudeau government's first budget hedges its projections all over the place. It believes its spending stimulus will generate substantial growth and jobs, but that belief is only partly reflected in its figures. It relies on tepid private-sector gross domestic product forecasts for its growth assumptions, but then lowballs those GDP projections to build a contingency adjustment into its numbers that is six times the one that was built into the last budget of the previous Conservative government. It expresses confidence in eventually eliminating the deficit, but it won't put a timetable on it.

If there's a message there, it would be that the deficits it is officially projecting – $113-billion over the next five years – almost certainly won't be that large. The government is confident that its plan will help it grow its way out of deficit. But there's a big gap between the growth the government hopes to achieve and what it's willing to commit to on paper.

Officially, the budget relies on the average GDP forecasts from private-sector economists to estimate its annual revenues. But as a contingency for the risk that the economy won't live up to expectations, it has cut those GDP estimates by $40-billion a year. That equates to a $6-billion-a-year cushion built into the budget for disappointment.

The budget even spells out just how bleak an economic outlook this contingency measure implies: It would be equivalent to assuming an average oil price of just $25 (U.S.) a barrel, rather than the $40 projected in the government's February survey of private-sector economists, and real GDP growth of just 1 per cent this year, instead of the survey's 1.4 per cent.

And it's not just for the current fiscal year; this degree of contingency is built into the deficit estimates for each of the next five years. Economists at Bank of Nova Scotia noted that this allows for a potential cumulative GDP disappointment over the next five years of $200-billion – equivalent to about 10 per cent of the size of the entire Canadian economy.

The government calls this "prudent," and some economists agree – if for no other reason than the economy's well-established capacity to disappoint in the post-Great-Recession era.

"Forecasters have been serially overpredicting growth in recent years – not just for Canada but in the U.S. and other advanced economies," Toronto-Dominion Bank's economics team wrote in a post-budget report.

But many others feel the contingency screams of overkill. With the Canadian economy having already been dogged by low oil prices and slow growth for more than a year, and with expectations for both oil and growth having already been lowered dramatically, they argue that if anything, the bigger risk is that the economy will outperform its already weak expectations.

On the other hand, the government's hopes for an economic boost from its big-spending budget plans may be overblown, especially in the shorter term.

The budget boasts that the combination of its infrastructure spending spree and middle-class tax cuts "will raise the level of real GDP by 0.5 per cent in the first year and by 1 per cent by the second year, compared to what would have been the case without these measures." Some private-sector estimates are considerably less optimistic. TD believes the budget's impact will add just 0.1 percentage point to real GDP growth this year and about 0.3 percentage point next year. TD's economists noted that the Finance Department's assumptions of the growth effects of fiscal stimulus (the so-called "fiscal multipliers") are considerably higher than what, for instance, the Bank of Canada estimates.

The budget estimates only reflect the degree to which the private-sector forecasters have predicted a growth boost from the budget, not the government's more rosy hopes. If the government is right, growth may top expectations and the deficits may shrink; if it's wrong, it has a big cushion to absorb that. As National Bank of Canada economist Warren Lovely noted, "$6-billion a year may be enough to protect against a more than one-percentage-point miss in real GDP."

Still, one can't help but hear the echo of previous Liberal governments of the 1990s – which, under the guidance of then-finance minister Paul Martin, made a habit of overly conservative budgeting followed by happy surprises on the budget balance at the end of each fiscal year. While the distinctly uncertain economic environment hardly guarantees that, the reality of the government's underlying expectations suggests it is more likely to beat its projections than underperform them.

The trick will be avoiding the temptation of dipping into any additional revenues generated by above-budget growth to fund still more of the pet programs on the government's wish list. If it sticks to plan and remains disciplined, the path back to balanced books needn't be as long and winding as this budget has mapped out. But for a government committed to spending its way to growth, that may prove an even sterner test than this budget; it will need to keep its hopes in check and its fears in sight.