Kevin Lynch is vice-chair, BMO Financial Group, the former clerk of the Privy Council and a former deputy minister of Finance.
Ottawa, we have a policy mix problem.
Growth in the Canadian economy screeched to a halt in the first half of this year, not surprisingly given the precipitous drop in world oil prices. But missed in the hoopla around when a recession is really a recession is that trend growth in Canada has been soft for some time now, masked by the boom in the energy sector and a frothy housing market. In short, as challenging as current conditions are, the longer term drivers of Canadian growth – increases in productivity and the labour force – are slowing and, with them, our future economic prospects.
So, how well are we deploying the mix of monetary, fiscal and structural policies in a co-ordinated fashion to deal with these twin growth challenges?
It is not a complicated judgment. Despite the continuing tremors from the global energy price shock that have sent official forecasts for growth this year tumbling from 2.6 per cent in the government's fall fiscal update, to 1.1 per cent in the Bank of Canada's July monetary report, the response has been to make adjustments to monetary policy. In fact, discretionary fiscal policy has actually been contractionary, as the government continued to reduce spending to eliminate the deficit despite the major changes in economic circumstances.
The Bank of Canada has lowered its overnight policy rate twice this year, by a total of 50 basis points. While signalling its concern about weakness in Canada's growth prospects, it is difficult to expect that, with short-term treasury bill rates averaging below 1 per cent for more than six years now, the most recent decline will appreciably stir business investment – although it may stimulate already strong housing demand. While the lower dollar will help expand net exports, a flexible exchange is a shorter term shock absorber not a longer term engine of growth. And with respect to slowing trend growth, monetary policy is not a solution to structural growth problems and, if anything, embedding unnaturally low real interest rates in the economy longer term may create ongoing distortions.
This raises the inevitable question: Why is fiscal policy sitting on the sidelines? Sure, we ran up federal government debt hugely during the financial crisis, but so did most other nations, and our deficit-to-GDP and net debt-to-GDP ratios both remain below all other G7 countries. Lowering the net debt-to-GDP ratio, which is a reasonable policy objective given its rise as a result of fiscal actions during the financial crisis, does not require a balanced budget, only that debt grows less quickly than nominal GDP. And this underscores the nexus between fiscal stability and economic growth –it is much harder to sustain fiscal balance in an economy where trend growth is slowing, and vice versa.
Where does this take us? Simply put, it is time to engage fiscal policy to provide demand support to the economy in a way that also raises our competitiveness, to complement this with structural policies to improve both productivity and labour force growth, and to rely less on unsustainably low interest rates.
One obvious fiscal measure that would meet these criteria would be a longer term program of strategic infrastructure investment by the federal government, with transparent criteria to distinguish economically strategic investments from politically opportune spending. Borrowing at low interest rates makes such investments attractive now; longer term, a dedicated revenue source could be considered. Since provinces share the same concerns about slowing growth and weakening productivity, there would be tremendous scope for alignment and partnerships. And opportunities might also exist with our large pension funds who are continually seeking suitable long term assets to invest in.
Such strategic infrastructure investments would likely include transportation systems, ports, public transit, and basic research to name a few core areas that would raise both private sector productivity and improve national competitiveness. And the more these investments were complemented by structural policies, the greater the impact on our longer term growth and living standards.
It's time to stir up the policy mix.