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C. Scott Clark is a former federal deputy minister of finance, and Peter DeVries is a former federal director of fiscal policy.

On Monday, Bill Morneau did something highly unusual for a finance minister. Rather than wait for the budget, which he announced would come on March 22, he released a revised prebudget economic and fiscal outlook. In other words, he released a major part of his budget early. This February update shows just how seriously the deficit outlook has deteriorated in just three months.

Forget $10-billion deficits. As a result of lower oil prices and lower economic growth, the Finance Minister now faces a deficit of $18.4-billion in 2016-17 and $15.5-billion in 2017-18. Forget eliminating the deficit in four years – that would have been a major policy error, given the worsening global economy. Deficit elimination is now a "long-term" challenge.

This leaves Mr. Morneau with only one fiscal anchor: a stable or declining debt/GDP ratio over the next four years.

What debt level should the minister adopt for his anchor? Currently, the federal debt is about 31 per cent of GDP, slightly higher than in 2008-09, before the financial crisis, and not much higher than it was 30 years ago.

There are, however, no economic reasons why a "stable" debt burden around 30 per cent is better than a "stable" debt burden around 35 per cent or even 40 per cent. Similarly, there are no economic reasons to justify a debt ratio of 25 per cent (the Conservative goal) or lower.

The experience of other countries also provides no help for determining an "appropriate" debt level for Canada.

Consider, for example, the total government debt burdens of Group of Seven countries, according to 2015 International Monetary Fund statistics: United States (79.9 per cent); Japan (126.0 per cent); Britain (80.3 per cent); Germany (48.4 per cent); France (89.4 per cent); and Italy (113.5 per cent). Canada's was the lowest debt burden, at 37.8 per cent, roughly the same as in 1988. Smaller, more open economies tend to have lower debt levels: Australia (17.5 per cent); New Zealand (8.8 per cent); Norway (minus 161.7 per cent); Sweden (minus 18.4 per cent); Denmark (6.3 per cent); and the Netherlands (34.8 per cent).

A key question the minister might want to consider is whether there is a level of debt beyond which growth will suffer. A study by Kenneth Rogoff and Carmen Reinhart of Harvard University in 2013 came to the conclusion that debt levels above 90 per cent of GDP would have a significant negative effect on economic growth. Despite valid criticism of their research methodology, their original conclusions have been supported by IMF research, although with much smaller negative impacts. Nevertheless, the relationship between growth and debt remains a much-debated issue among economists.

In Canada, there was a significant interest-rate premium placed on its debt in the late 1980s and early 1990s, when the debt ratio approached 70 per cent. However, the fiscal situation then was totally different than it is today.

So where does this leave the Finance Minister in setting his fiscal anchor?

Mr. Morneau inherited a debt ratio of about 30 per cent, and it may be difficult for him to set a higher debt target so soon after the election. A lower debt target would also be problematic, since it would mean rejecting much of the government's policy platform. He must decide how prudent and credible he wants to be in planning his first and subsequent budgets.

In our view, there are two guiding "fiscal principles" that he should follow.

First, commit to maintaining a debt level averaging about 30 per cent of GDP over the next four years.

Adopting this fiscal anchor should still give the government adequate flexibility in implementing its policy agenda. Nevertheless, there is an upper limit that cannot be broken if fiscal and political credibility are to be maintained. Based on the minister's February update and the cost of his party's election promises, he may already be very close to that limit.

To maintain a stable debt level around 30 per cent of GDP, the deficit must be no higher than $22-billion in 2016-17 and then about $30-billion for each of the next four years (about 1.5 per cent of GDP). This will require that the government show restraint in implementing its election promises.

Second, if the government does want to implement a larger political agenda with higher structural spending (excluding infrastructure), then this additional spending should be financed through revenue increases and/or program cuts, not larger deficits and higher debt. Do not repeat what happened in the 1980s. Much of government spending should be financed by current taxpayers, not by future taxpayers.

The government must stick to this anchor. Fiscal credibility is hard to earn but easy to lose. Once lost, it's hard to regain.

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