Stephen Gordon is a professor of economics at Laval University in Quebec City and a fellow of the Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE). He also maintains the economics blog Worthwhile Canadian Initiative and can be followed on Twitter.
The Canadian federal government’s deficit in fiscal year 1992-93 was 5.6 per cent of GDP; five years later, it recorded a surplus.
Now that so many governments are mired in a spiral of large deficits and rising debts, this example of how a government could repair its finances without plunging its economy into recession is drawing a certain amount of attention. If Canada could eliminate its deficit in the 1990s, why can’t the U.S., the U.K. and other countries do so now? Unfortunately, it’s not that simple.
Firstly, Canada did not deal with its deficit while the economy was in recession; the Chrétien government’s austerity program began after the economy had recovered from recession. Public sector employment increased during the recession of the 1990s, and government job cuts began when private-sector employment had recovered from its pre-recession peak and was growing strongly.
Secondly, the Bank of Canada could and did offset the contractionary effects of fiscal austerity with an aggressively expansionary monetary policy. Policy rates fell by 5 percentage points in the months following the 1995 austerity budget, and this helped contribute to a continued depreciation of the Canadian dollar. Although fiscal austerity reduced domestic demand, Canadian exporters were able to make up the difference by exporting to a fast-growing U.S. economy.
I can’t think of any country where the conditions for a (relatively) pain-free deficit-reduction program are satisfied. U.S. employment has barely begun to recover from the recession, and current rates of job creation suggest that it will be many years before its labour markets reach pre-crisis levels of activity. Moreover, the Federal Reserve doesn’t have the room to manoeuvre that the Bank of Canada did in 1995: interest rates are already at the lower bound. And unlike Canada in the 1990s, the U.S. doesn’t have a rapidly-growing trading partner ten times its size.
Sometimes, in countries such as Greece, austerity is unavoidable: when lenders refuse to lend, then governments must stop borrowing. But freely choosing to impose austerity on an economy that is still in recession is a pointless exercise in making a bad situation worse.
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