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US President Barack Obama makes a statement addressing negotiations on a deal to avert a ruinous early August debt default in July, 2011. (JEWEL SAMAD/AFP/Getty Images)
US President Barack Obama makes a statement addressing negotiations on a deal to avert a ruinous early August debt default in July, 2011. (JEWEL SAMAD/AFP/Getty Images)


Stimulus spending: Two words that spell trouble Add to ...

When the collapse of Lehman Brothers Holdings Inc. in September, 2008, turned a U.S. mortgage crisis into global financial meltdown, governments in the United States and Europe staved off catastrophic banking failures by providing debt guarantees and injecting equity. As the crisis subsided, national treasuries fortuitously profited from bank equities purchased at the nadir of the recession. Act One of governments’ response to the crisis was clearly a winner. Regrettably, Act Two has been a gigantic loser.

John Maynard Keynes’s theory that governments should spend their way out of recession proved disastrous during the recessions of the 1970s and 1980s. Interest rates and inflation sky-rocketed while economic growth remained stagnant, a phenomenon that became known as “stagflation.” Given this woeful legacy, it seemed certain that the stimulus spending theory had no greater chance of rising from the grave than the late economist himself.

But rise from the grave it did. In a desperate effort to end the 2008 recession as quickly and painlessly as possible, “everyone is a Keynesian” became the rallying cry. In the three-year period ending last week, an orgy of stimulus spending pushed the U.S. national debt clock ahead by more than 40 per cent to $14.6-trillion (U.S.). Total gross government debt of the 27-country European Union jumped by more than a third over the 2008-2010 period, to €9.8-trillion. Yet after the largest government spending in history, the U.S. and EU economies remain stagnant.

Rather than stimulating economic recovery, the massive government spending has had the opposite effect. The Obama administration’s fixation on multiple, debt-fuelled, stimulus injections and quantitative easing (i.e. printing money) has taken the United States progressively closer to insolvency, causing a nervous private sector to eschew expansion in favour of hunkering down and hoarding cash. Unemployment remains high, consumer confidence low and economic growth anemic. This, combined with President Barack Obama’s anti-business rhetoric, has hobbled the great entrepreneurial engine that always lifted the country out of economic doldrums in the past.

The economic picture is similarly bleak in many EU countries, and now the sovereign debt crisis threatens financial Armageddon. It is now clear that rather than creating economic recovery, those trillions in stimulus spending have wrought a much longer and more devastating economic malaise.

Canada is one of the few countries that cut spending and paid down debt in the years before the financial crisis. It entered the recession with one of the strongest balance sheets in the Organization for Economic Co-operation and Development. The federal government’s decision to get on the stimulus-spending band wagon increased the national debt by 23 per cent, to $560-billion since the fiscal year that began in April, 2008. While this deficit spending is a regrettable departure from years of fiscal prudence, the fact that Canada entered the recession with fiscal surpluses means rebalancing the books within three years should be an attainable objective.

Throughout the financial crisis, Canada’s mortgage portfolios remained sound and the banking system gained international acclaim. Strong demand, and prices, for our natural resources also helped us weather the storm. Unemployment levels have fallen steadily from their September, 2009, high to the current level of 7.2 per cent (which, interestingly, is less than the Canadian 15-year historical average of 8.5 per cent). As the sovereign debt crisis sweeps through the euro zone and the United States struggles to maintain financial respectability, Canada is viewed globally as a prudent and safe refuge.

Given this context, one would have thought that the last words passing any Canadian politician’s lips would be “stimulus spending.” Yet when Finance Minister Jim Flaherty appeared before the House of Commons finance committee on Aug. 19, there was NDP finance critic Peggy Nash, calling for another round of “counter-cyclical” stimulus spending. The news media seemed equally oblivious to the cause of the sovereign debt tsunami breaching European and U.S. shores. In the days after Mr. Flaherty’s appearance, the most common question posed in his interviews focused on another round of stimulus spending.

Canada is not immune to the economic struggles of our largest trading partner or the very serious sovereign debt crisis in the euro zone, the world’s largest economic unit. The fallout is likely to stress Canada’s economic resiliency to the maximum. Adding more debt to the national balance sheet would reduce that resiliency, putting Canada on the same regrettable path to financial ruin that Keynesian theories have taken the United States and the EU.

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