Jean-François Perrault is chief economist at Scotiabank.
The Canadian economy is slowing, as it is confronted with the broadening impact of declining commodity prices and growing uncertainty. Economic growth is predicted to be just over 1 per cent this year, according to Scotiabank's outlook, which is well below potential and significantly lower than projected by the Bank of Canada.
Fiscal stimulus is temporarily needed to help raise the pace of economic activity. In our view, the Canadian economy needs fiscal stimulus in the order of $20-billion. This would amount to roughly 1 per cent of GDP in the second half of 2016 and the first half of 2017. This stimulus would need to be over and above the deficit that will result from weaker economic conditions, which the government estimates will be $18-billion in fiscal year 2016-17. This would lead to a federal deficit of nearly $40-billion for the fiscal year beginning this April.
There are three key considerations in the development of a stimulus package:
- It must be designed to have as rapid an impact on the economy as possible;
- It must also raise the productive capacity of the economy, thereby raising long-term growth prospects; and
- It must help smooth and facilitate the adjustment in provinces that are most negatively affected by the decline in commodity prices.
There are a few options for achieving this.
Measures with the most immediate impact would involve providing tax rebates to lower-income households. However, past spending patterns indicate that only a fraction of this would be spent. While timely, its relatively low translation into increased spending warrants caution.
Other options could include time-limited tax credits to encourage investment in capital goods. These could encourage firms to invest this year, and help offset the rise in the cost of imported capital goods. The increase in investment would help the long-term growth of the economy, while generating an immediate increase in demand.
Infrastructure spending should be increased beyond the levels committed to in the Liberals' electoral platform. The challenge is identifying new, easily and quickly implementable projects to boost demand within the next 12 months and focus on investments that raise productivity.
A strict filter should be applied to ensure projects are economically meaningful and incremental to current investment plans. The infrastructure package could be designed to partly target provinces most affected by low commodity prices, on the condition that projects are of economic significance and could be substantially completed by the second half of 2017.
To help smooth the restructuring over the next two years, the federal government could extend the duration of employment insurance benefits and provide additional funding to help retrain displaced workers. Finally, the government could consider immediately reducing EI premium rates from their current levels to encourage job creation.
At roughly 1 per cent of GDP, a package encompassing these elements would provide a relatively rapid boost to economic activity, lead to a sizeable reduction in excess capacity by mid-2017 and lay the foundation for stronger growth over the long run.
Clearly, proceeding with a package of this magnitude would significantly increase the deficit in fiscal year 2016-17, likely near $40-billion. This is easily manageable given Canada's low net debt-to-GDP, in an absolute sense and relative to other G7 economies, our credit rating, and our cost of funds.
The key is to maintain fiscal credibility. The government had committed to bringing down the debt-to-GDP ratio, while targeting a return to balance by the end of its mandate. The latter is not necessary, and an overly aggressive consolidation path would pose a serious headwind to growth in the latter part of the mandate and undermine the impact of the investments made in the stimulus package.
The key element of the government's fiscal strategy should be to achieve a declining debt-to-GDP ratio once the economy no longer requires policy support. As others have noted, this can be achieved with a deficit in the $20-billion range, which is easily achieved. Canada's net debt-to-GDP ratio would remain the envy of the G7.
This is not to say the government gets a blank cheque. Fiscal resources are limited. Markets will tolerate a well-designed plan – unless the new expenditures are unproductive or wasteful.
A well-designed stimulus package has the potential to help the Canadian economy achieve "escape velocity." Given the challenges we face, the government should not disappoint with a timid response to the deterioration in the outlook.
The economy needs a boost, and fiscal policy should provide it.