Skip to main content

Finance Minister Jim Flaherty photographed during a an interview in his Parliament Hill office on Jan. 30, 2013, in Ottawa.Dave Chan/The Globe and Mail

Officials at Finance Canada – and economists on Bay Street – are asking themselves some pretty fundamental questions.

Does deficit spending boost or hurt economic growth? Do spending cuts hurt or help the economy?

As crunch time approaches on the 2013 federal budget, there is a lot weighing on getting these answers right.

Unfortunately for the team of public servants working to help Finance Minister Jim Flaherty erase the deficit by 2015, there are no easy answers.

An internal briefing note to Mr. Flaherty's deputy minister, Michael Horgan, shows finance officials have been researching these very questions. International economists have many competing formulas for calculating the cause and effect between cuts or stimulus and economic growth.

"There is no one size fits all multiplier," states the briefing note, referring to formulas that aim to calculate links between fiscal policy and economic growth.

As finance officials reviewed recent studies, a common theme they found is that the answer depends on how much debt a country is carrying.

If a country's debt load is already drawing international concern, more stimulus isn't going to help.

"Similarly, for credible fiscal consolidation, the multiplier is smaller because confidence is improved, the risk premium falls and precautionary savings decline," the note states.

Finance officials pointed to one study in their briefing note that identified 85 per cent of GDP as the average debt load point where debt becomes a drag on growth.

So what does this all mean for Canada? Those parts of the briefing note – which is dated June 28, 2012, and obtained through Access to Information – are blacked out. But the very existence of the note provides some insight into the concerns at the highest levels of the finance department.

Ottawa often likes to say its debt situation is dramatically better than other major nations. In some ways that's true. Ottawa likes to measure its debt as "net debt" – which allows it to count public pensions like the massive, fully-funded holdings of the Canada Pension Plan as assets. Ottawa can point even more narrowly to federal net debt, which makes Canada look even better.

But many international comparisons of national debt loads prefer to use gross debt of all levels of government. By that measure, Ottawa doesn't look so good.

"For borrowers, gross debt is what matters," said Stephen Cecchetti, in an email from Basel, Switzerland, where he is the economic adviser and head of the monetary and economic department for the Bank of International Settlements.

Mr. Cecchetti co-authored the BIS report that listed 85 per cent debt-to-GDP as a trigger for concern.

"It is the total level of debt, and the required payments, that are relevant for resilience to income and interest rate shocks. Our interest in fragility leads us to study gross debt," he said. "The gross/net distinction is one that we have spent quite a bit of time thinking about."

An October report by the International Monetary Fund projected Canada's gross government net for 2012 at 87.5 per cent of GDP – compared to a world average of 81.3 per cent – and net debt at 35.8 per cent – compared to a world average of 48.2 per cent.

The lack of clear answers or formulas helps understand why economists repeatedly stress the degree of uncertainty in the economy. Not only must they weigh the impact of Canadian fiscal policy on growth, but also the impact of stimulus and restraint among Canada's trading partners.

The United States, for instance, faces high debt levels and a fiscal policy that is highly uncertain at the moment as Democrats and Republicans feud over budget cuts.

Mr. Flaherty relies on private sector economists to do the heavy lifting in terms of weighing all of the uncertainty in the global economy. Those economists have until Tuesday to submit their numbers to the department as to what Ottawa should expect in terms of growth and revenue over the coming years.

On Friday he said revenue is coming in weaker than expected. Still, he promised to strike a "balance" between measures to boost growth and spending cuts to erase the deficit by 2015.

Bank of Montreal chief economist Doug Porter, who is among the group of economists submitting reports, said Canada's debt load does mean it has less room to react with stimulus if needed than before the recession.

However Mr. Porter said Canada is right to boast about net debt, given that other countries like the U.S. have not put enough money aside to fund their public pensions.

"We do have these funds set aside to help fund CPP and I think that's reasonable to take that into account when you're trying to compare the credit worthiness of the two countries," he said.

Bill Curry covers finance in The Globe and Mail's Ottawa bureau.