Economy feels the gain (and pain) from Ottawa’s spending spree

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The gain and pain of Canada’s coronavirus spending spree are coming into focus.

Evidence is beginning to accumulate that the economy may already be rebounding. First came unexpected job gains in May. Now, there are preliminary data from Statistics Canada that retail sales also rebounded unexpectedly that month, with a 19.1-per-cent increase that followed a precipitous 25.2-per-cent drop in April.

And confidence indicators for consumers and businesses are both increasing – although after steep drops caused by the onset of the novel coronavirus and the economic lockdown.

Set against those signs of economic rebound is the downgrade in the federal government’s credit rating by Fitch Ratings. The credit-rating cut was largely expected and didn’t have a significant effect on bond markets this week. But it does underscore the increasingly tough balance Ottawa will need to strike between continued support for Canadians and the long-term fiscal health of the country.

Still, the economic momentum is uphill, not downhill. Capital Economics, for one, is adopting a less pessimistic outlook for consumer spending, saying it now sees consumption falling by 3 per cent from previrus levels by the end of 2020, better than the 5-per-cent drop it had previously forecast.

That’s improved, but still not cause for celebration, notes Stephen Brown, senior Canada economist at Capital Economics. “This is a huge improvement from the second quarter, but it would still be one of the worst recessions in post World War II history.”

Mr. Brown ascribes much of the upside in consumer spending to the effects of government intervention, particularly the Canada Emergency Response Benefit. Mr. Brown said it’s likely some lower earning Canadians who were not working full time saw their incomes increase because of CERB’s structure.

One major uncertainty in forecasting consumer spending is the fate of the extra billions that Canadians have stashed away since the economic lockdown began. The household savings rate soared to 23.5 per cent in the second quarter, according to Capital Economics’ estimate.

Savings rates typically rise as the economy falls. But as the chart below shows, that spike is far sharper than what Canada experienced in the wake of the 2008 financial crisis. Then, the savings rate hit a peak of 5.4 per cent in the first quarter of 2010. The savings spike in 2020 looks set to top even the recession of the early 1980s, when the rate hit 21.6 per cent in the first quarter of 1982 (at a time of double-digit interest rates).

How much money is left sloshing around in bank accounts? Mr. Brown estimates that, since the onset of the virus, Canadians have built up $86.9-billion in excess savings (which he defines as savings above the average of the two quarters preceding the recession.) By contrast, it took Canadians three years to amass that level of excess savings following the 2008 global crisis.

Mr. Brown said he expects Canadians who maintained their employment income, and were therefore able to save more in recent months, will spend some of those funds as retailers reopen. That will offset diminished consumption by those who have lost their jobs, or had work hours reduced. But only to a point – his forecasts assume Ottawa continues to offer some form of income support after the scheduled expiration of the CERB in early October. If Ottawa were to simply turn off its emergency spending, the uptick in Canada’s economic outlook would vanish. “That would change the picture dramatically.”

But balanced against that imperative is the emerging need for long-term fiscal clarity, if not fiscal discipline, says Jack Mintz, president’s fellow at the School of Public Policy at the University of Calgary.

Mr. Mintz said it’s clear the government needed to intervene to offset the severe economic effects of the coronavirus and the lockdown used to slow down the contagion, and the CERB helped to buoy consumer spending.

But the downgrade from Fitch is an early sign that Ottawa’s fiscal capacity, while large, is not boundless. “I would say it’s a warning signal,” he said. The analysis by Fitch includes provincial debt, and points to the fiscal situation of the provinces as an area of concern.

Part of the issue may be the lack of certainty over Ottawa’s intentions, exacerbated by the federal government’s continuing refusal to set a date for releasing a full budget. (There will be a fiscal update on July 8, with Prime Minister Justin Trudeau describing that exercise as a “snapshot” of federal finances.)

There will be pressure through the summer and fall for Ottawa to extend the CERB, and to delay tax payments, Mr. Mintz said, adding the government should lay out its plans, even though there is significant economic uncertainty. “They need to start clarifying expectations.”

Tax and Spend is a weekly series that examines the intricacies and oddities of taxation and government spending

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