The most, er, interesting chart in the federal budget appears on page 54 of the 739-page brick tabled on Monday by Finance Minister Chrystia Freeland. It tracks the yield on 10-year government of Canada bonds since 1990 and plots the dramatic decline in interest rates over three decades. It is there to buttress Ms. Freeland’s claim that Ottawa’s current spending spree is a no-brainer.
“In the current low-interest rate environment, growth-enhancing investments can help improve fiscal sustainability by raising [gross domestic product] growth more than they raise costs in terms of increased debt service over the longer term,” the budget document explains.
This is the narrative Justin Trudeau’s government has embraced since the Prime Minister last year called the COVID-19 pandemic an “opportunity for a reset” of the Canadian economy. And, with an election on the horizon, Ms. Freeland’s first budget suggests the government is hellbent on sticking to it.
You might even say come hell or high water.
Students of Canadian political history will recall the latter expression was made famous by Paul Martin, in 1995, when he introduced the mother of all austerity budgets. Despite the political unpopularity of his cuts, Mr. Martin insisted he would not be deterred – though it was not like had much choice. At the time, financial markets began to fret that Canada was about to follow Mexico in experiencing a major debt crisis and currency devaluation.
“The debt and the deficit are not inventions of ideology. They are facts of arithmetic. The quicksand of compound interest is real,” Mr. Martin said. “In this budget we are bringing government size and its structure into line with what we can afford.”
The 1995 budget embodied what is known as the “Washington Consensus,” a term formulated in 1989 by economist John Williamson to describe a set of broadly free-market policies advocated by the International Monetary Fund, World Bank and U.S. Treasury Department aimed at ending the debt spiral that had left several Latin American countries at the mercy of their creditors. The policy consensus described by Mr. Williamson, who died last week at 83, was based on “macroeconomic discipline, a market economy and openness to the world.” It shaped economic policymaking for a generation.
Until now. The pandemic drove the final nail into the coffin of the Washington Consensus as governments across the West pumped trillions of borrowed dollars into their economies. In the past year, typically middle-of-the-pack Canada has outspent and outborrowed almost every other developed country. And Ms. Freeland has no intention of stopping now.
Good Liberal that he is, Mr. Martin is not about to repudiate Ms. Freeland, for whom he has an evident fondness. But you have to wonder what he thinks – really thinks – about the new math in Ottawa.
“The best way to pay our debts is to grow our economy,” Ms. Freeland said in announcing plans to spend more than $100-billion over three years on stimulus measures despite threats of economic overheating. “In today’s low interest rate environment, not only can we afford these investments, it would be short-sighted not to make them.”
Indeed, according to Ms. Freeland, thanks to the additional economic growth created by federal spending, the budget will (almost) balance itself by 2025-26, when the federal deficit is projected to fall to 1.1 per cent of GDP, from last year’s record-setting 16.1 per cent and 6.4 per cent this year.
Ms. Freeland is counting entirely on non-inflationary economic growth to reach that goal, however. Non-pandemic-related program spending will continue to grow, while new taxes on digital giants and the wealthy will raise only modest sums. The digital tax, for instance, is slated to bring in only $200-million this year and $900-million by 2025 – a piddling amount given the publicity it generates.
This all brings us back to that chart on page 54. The Finance Minister might have a more persuasive story to tell were it not for the hook-like tail on the chart that reflects the spike in bond yields since the beginning of 2021. It shows that investors are beginning to worry about inflation again as all that extra federal spending risks stoking more demand than the economy can satisfy.
Ms. Freeland’s budget projects Ottawa’s cost of borrowing, while still low, will average 1.5 per cent this year, or 0.6 percentage points more than the level projected in November’s fall economic statement. The average yield on 10-year federal bonds is forecast in the budget to rise to 2.7 per cent by 2025. But inflation could easily upend Ms. Freeland’s projections, forcing the Bank of Canada to raise interest rates to prevent prices from getting out of control.
We have witnessed such a scenario in Canada and elsewhere before. The Washington Consensus offered a road map for ending this vicious cycle. Ms. Freeland seems determined to take a different path.
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