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Economy Lab

No lesson for U.S. from Canada's 1990s deficit fight Add to ...

When our neighbours suffer a misfortune, we sometimes comfort them with anecdotes of how others have faced and overcome similar problems. The current U.S. fiscal situation is a case in point. Their deficit and debt problems are seemingly out of control, so it seems appropriate to point out to Americans that Canadian governments turned around our own debt spiral in the mid-1990s. The process was not without pain, but we managed to avoid a recession. If we can do it, then why can't they?



Unfortunately, there are several reasons why our experience of the 1990s is of little help as a guide for U.S. policy-makers today. Firstly, the deficits they are looking at are much worse than what we experienced. According to the IMF, the U.S. general government deficit (federal plus state/provincial) was 12.7 per cent of GDP in 2009; the worst it ever got in Canada was 9.1 per cent.



Canadian policy-makers in 1990s also had something that their U.S. counterparts don't have now: a central bank that is in a position to loosen monetary policy in order to counter the effects of a fiscal tightening. In the two years following the federal government's austerity budget of 1995, the Bank of Canada cut interest rates by more than 5 percentage points. In addition, the depreciating Canadian dollar made it possible to shift from producing for the domestic market to producing for export.



This option is unavailable to the United States. The Federal Reserve has already reduced interest rates as low as they can go, and even after two rounds of quantitative easing, the U.S. dollar has not depreciated as much as U.S. policy-makers might like. In any case, the sheer size of the U.S. economy makes it difficult to make use of exports as a growth driver. Canada could export to an economy ten times as large; there is no economy ten times the size of the U.S.



Much as we might wish to say soothing words to comfort our American neighbours, the stark truth is that their predicament is much worse than what we had to deal with, and they are going to have to face it using fewer tools than were available to us.



Canadian monetary policy: 1990-2000



General government balance: Per cent of GDP



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