Stephen Poloz, the Governor of the Bank of Canada, just dropped an unmistakable hint about what he'd like to see in the Trudeau government's first budget, expected in March. "The Bank's current base case projection shows the output gap closing later than was anticipated in October, around the end of 2017," the Bank said on Wednesday as it announced that, despite current economic weakness, it was not lowering its benchmark interest rate. "However, the Bank has not yet incorporated the positive impact of fiscal measures expected in the next federal budget."
Translated from central banking diplomatese into English, it sounds something like this: "The economy is weaker than we thought – the Bank expects anemic economic growth of just 1.4 per cent this year. But if Ottawa runs a bigger-than-expected budget deficit? Well, that would be a positive. We'd revise our economic forecast – up."
If Finance Minister Bill Morneau needed added political cover to run a deficit larger than the $10-billion shortfall for 2016-17 promised during the election campaign, he got it. He's already received calls for deficit stimulus from a lineup of Bay Street economists, and earlier this week former Bank of Canada governor David Dodge said he hoped the feds and the provinces would run a combined shortfall of $40-billion this year, which would mean a federal deficit in the neighbourhood of $25-billion.
Remember when finance ministers only got grief for failing to cut the deficit? Times and circumstances change. And under the circumstances, it's hard to argue against Ottawa, and some provinces, spending modestly beyond their deficit targets. In a country with a low debt-to-GDP ratio, keeping that ratio stable, or even having it rise slightly in the event of an economic downturn, won't come close to breaking the piggy bank. And a little more deficit spending could, at least in the short run, have a mildly positive impact on the economy.
But the current "crisis" that provoked calls for bigger deficits has to be put in perspective: What crisis? The Canadian economy isn't the picture of health, but it isn't in recession, or at least most of it isn't. There's no international banking meltdown; there's no global recession. This isn't 2009, the last time Ottawa had no choice but to switch all policy levers to full panic mode. And while the future is impossible to predict with absolute certainty (see, ahem, the Bank of Canada's constantly revised economic forecasts), the probability is low that 2016 is about to turn into a rerun of the Great Recession.
The Canadian economy is, however, going through a painful transition. The reason is low oil prices. In the oil-producing provinces – Alberta, Newfoundland and Labrador and Saskatchewan – businesses are pulling back spending more sharply than expected, with unemployment rising by 2.5 percentage points and employment insurance claims up a whopping 31.6 per cent since late 2014, with more pain to come.
But in the rest of the country, the economy is relatively healthy. Since late 2014, employment in the other seven provinces and three territories is up 1.1 per cent, and the number of unemployment insurance claims has fallen.
In other words, Canada's private sector economy is to a large extent rebalancing itself, with a lot of help from a lower loonie, itself helped along by Mr. Poloz's interest rate cuts. Businesses are shifting investment and employment from the oil patch to more profitable opportunities elsewhere, and from Alberta to central Canada. For example, the number of Canadians moving to Ontario from another province is at its highest level since 2002, while the number of people moving to Alberta is at its lowest point in half a decade. Unless oil prices rise, this is exactly the kind of adjustment we should expect to see more of.
But all of this necessary rebalancing in the free market isn't happening overnight, and it isn't happening without pain for real people. What's more, while a lower currency and oil price have had some positive effects in Canada's non-oil industries, the bad news is that the collapse in the price of oil has been a net negative for Canada.
The Bank said Wednesday that falling oil prices have lowered the wealth and incomes of Canadians, and that could translate into lower consumer spending and lower business investment, even outside the oil sector. "The effect from this channel has been slower to materialize," says the Bank, "and is expected to peak much later, toward the end of 2017." Even if oil prices don't go lower, there could be more economic shoes yet to drop.
The bottom line on Ottawa's bottom line is that a bigger deficit would deliver a bit of an economic upside, at low cost – interest rates have never been lower – and with little risk. It's why Mr. Poloz decided to keep monetary policy on hold for now, in anticipation of Mr. Morneau's first budget.