Finance Minister Bill Morneau says fiscal policy such as increased government spending will need to play a larger role in the event of an economic downturn because central banks can do little with global interest rates near historic lows.
While stressing that the Canadian economy remains strong and that none of the main private-sector economists is forecasting a recession, Mr. Morneau said Monday that his forthcoming budget will need to be cautious in terms of new spending so Ottawa has room to act if needed.
“In a situation of low interest rates, obviously the response to any economic challenges is likely to be different than if we had high interest rates,” he told a group of students at Ryerson University in Toronto as he launched prebudget consultations and provided an outline of his priorities.
“Historically, when the economy’s faced challenges, central banks have reduced interest rates. But given that interest rates are already at a low rate, that tool is not there in the same way, which means that the response to economic challenge is much more about investments that the government can make – what’s called fiscal approaches," he said.
"And that’s why we need to always maintain a strong balance sheet, always maintain the ability to make those investments, which is why that’s one of the key objectives that I’m working towards and that the Prime Minister has asked me to work towards in how I move forward with the budget.”
Mr. Morneau and the government have faced criticism for running deficits during a period of economic growth. However, the Finance Minister repeated his pledge to focus on reducing the size of the federal debt as a percentage of GDP. He also said a period of low interest rates is a good time for the government to spend in areas such as infrastructure and education to encourage long-term economic growth.
His December fiscal update said the deficit for the current fiscal year is projected to be $26.6-billion – up from $14-billion last year – and the debt-to-GDP ratio will be 31 per cent, up from 30.8 per cent in the 2018-19 fiscal year.
His comments regarding monetary policy are similar to recent arguments from central bankers at home and overseas, suggesting that government spending should carry more of the load for stimulating the economy in the next major downturn.
“That’s almost a global statement … There’s a growing concern that monetary policy has done most of what it’s able to do,” Bank of Canada Governor Stephen Poloz said in an October news conference.
Bank of England Governor Mark Carney told the Financial Times that central banks around the world do not have the room to cut interest rates to the same degree as in past recessions.
“It’s generally true that there’s much less ammunition for all the major central banks than they previously had, and I’m of the opinion that this situation will persist for some time,” Mr. Carney said. “If there were to be a deeper downturn, that requires more stimulus than a conventional recession, then it’s not clear that monetary policy would have sufficient space.”
The Bank of Canada’s current policy rate of 1.75 per cent, the highest in the Group of Seven, does give it more room to manoeuvre than other central banks. But Mr. Poloz has argued that government spending would be a more efficient tool to stimulate growth.
“We know since 1936, when [British economist John Maynard] Keynes wrote about it, that fiscal policy is at its most powerful in the situation where interest rates are very low and expected to stay there – so, bang for buck is higher – and monetary policy is at its most feeble,” Mr. Poloz said in December.
Mr. Morneau said some of the key themes of his budget will be climate change, health care, gun control and reconciliation with Indigenous peoples. No date has been set, but the federal budget is normally released in February or March.
With files from David Parkinson