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Harper’s surplus pledge undermines Poloz’s efforts to battle new reality

First, a thought on the Bank of Canada's rate cut Wednesday. And then, straight into an argument about how the Stephen Harper government appears intent on making Stephen Poloz's job more difficult than it has to be.

Observers expressed shock at the Bank of Canada's decision to cut its benchmark interest rate a quarter point. Fair enough. None of the economists Bloomberg News polled ahead of the decision saw it coming. But if you lost a lot of money Wednesday, then it is your fault. The moment you heard the longest serving member of the Governing Council say the collapse in oil prices was "bad for Canada," you should have hedged your bet that Canada's benchmark rate would stay at 1 per cent for infinity. The age of extraordinary guidance is over — central bankers, especially Canada's Stephen Poloz, have been explicit in telling us so. Any suggestion that Mr. Poloz lost credibility Wednesday misses the mark: he warned everyone that a surprise was possible if the situation demanded it. The 55-per-cent plunge in oil prices since June caught everyone off guard. When the the quarterly Business Outlook Survey showed investment intentions collapse with the oil price, Mr. Poloz had a strong incentive to respond with lower borrowing costs. He was doing his part to give Canada's economy a chance to survive on something other than oil.

Unfortunately, Mr. Poloz appears to have stepped into this fight alone. The real surprise Wednesday, at least to me, was Finance Minister Joe Oliver's unwavering commitment to fiscal austerity on a day the backdrop so radically changed. The drama of Mr. Poloz's rate cut presented Mr. Oliver with an opportunity to step away from the Harper government's outdated balanced-budget pledge without losing face. He didn't take it. "What it's going to do is reduce our flexibility, but it's not going to undermine the commitments we've made nor is it going to undermine our ability to actually get a balanced budget next fiscal year," Mr. Oliver told Bloomberg News in Davos, referring to the same oil-market crash that just had prompted the Bank of Canada to set a new course.

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I wrote about Ottawa's blind devotion to rigid fiscal discipline earlier this week. Those observations were based on the world as it looked last week, a world where things looked bad, but maybe not dire. The opportunity cost of the Harper government's insistence on equating good economic policy with balanced budgets was a missed chance to reorient Canada's economy. On Wednesday, the most sophisticated collection of economists in the country concluded that something is very wrong. The balanced-budget pledge was made years ago when Canada was among the first recover from the financial crisis. There is a new reality now and the federal government is undermining the Bank of Canada's efforts to cope with it.

We cherish the independence of central banks. But that cherished principle doesn't mean the monetary and fiscal authorities should ignore each other. Their policies should be complimentary. One of the reasons the U.S. recovery was so painfully slow is that governments cut spending at the same time the Federal Reserve was mounting its historic stimulus effort. Congress and various state legislatures became anchors that delayed liftoff.

That is now what is happening in Canada. The central bank in its latest quarterly economic report says governments' contribution to the increase in Canada's gross domestic product in 2013 and 2014 was zero. This year, the central bank estimates a contribution of 0.2 per cent, and in 2016, 0.3 per cent.

This is what austerity looks like. Let's go back to January 2007, when we naively believed everything was great. This would have been the moment to make the big debt payments that the Harper government now argues are so vital to protect Canada's long-term prosperity. What did Ottawa and various provincial governments do? Spend. Their contribution to GDP growth in 2006 was 0.8 per cent and there was enough spending in the pipeline for the Bank of Canada to foresee a contribution of 0.7 per cent in 2007. At least Canada's fiscal authorities are consistently procyclical: they pump money into the economy when it is least needed, and they run for cover with everyone else when times get tough.

An argument against the mantra of balanced budgets is not a plea to shovel money out the door. Things are grim, but the global financial system isn't melting down. The Bank of Canada didn't actually adjust its forecasts much. The parts of the Canadian economy that sell non-energy goods and services to the U.S. are doing rather well. Canada fought hard to achieve fiscal credibility. One doesn't throw that away in a panic.

But that credibility is precisely why the emphasis on austerity is unnecessary. No one doubts Canada's commitment to keeping spending under control. The the federal government was one of the few sovereigns that retained its triple-A credit through the crisis. The point is this: there is no economic imperative to record a budget surplus in 2015. If the Harper government chooses to do so, it is acting on ideology. And as the financial crisis showed, ideologues make poor economic stewards.

Kevin Carmichael is a senior fellow at the Centre for International Governance Innovation, based in Mumbai.

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