Federal Finances on a Razor’s Edge

The federal government can’t continue to ignore the warning signs of a slowing economy. It should limit discretionary spending now

The recently-released Economic and Fiscal Update demonstrates the federal government’s proclivity for marked increases in deficit-financed spending despite warning signs of a slowing economy.

New borrowing and a larger deficit increase the risk to federal finances should a recession occur.

The federal update pegs the deficit at $26.6 billion for 2019-20 – $6.8 billion more than originally planned for in the 2019 budget released last March. In 2020-21, the deficit is projected to be $28.1 billion – and that’s excluding several costly campaign promises.

The increased deficits largely reflect actuarial revaluations of employee pension and benefits, compensation to dairy farmers, and a revenue agreement for the Hibernia project in Newfoundland and Labrador.

It’s particularly concerning that higher-than-anticipated spending in areas such as employee pensions and benefits contributed to the larger deficit because it demonstrates that the government didn’t adequately account or prepare for changes in the economy (for example, lower interest rates), how those changes could affect its financing, and that it’s not positioned to absorb increases in spending.

This is worrying lapse should a recession occur.

If a recession occurs next year, as some experts predict, the state of federal finances would be become much worse. Not only would spending automatically increase while revenues decrease (due to automatic stabilizers such as employment insurance) but the government would almost certainly increase spending in an attempt to stimulate the economy.

Prime Minister Justin Trudeau’s mandate letter to the minister of finance specifically requested that he retain “fiscal firepower” should it be needed to respond to an economic slowdown.

But according to a 2018 study, the federal deficit could have reached $42.7 billion in 2019 even if a mild recession (similar to 1991-92) occurred and the government responded in a similar way as it did then. If a deeper recession occurred, similar to 2008-09, the annual deficit could have skyrocketed to $120.5 billion. Remember, this is not a four-year deficit, this is the deficit in a single year.

And yet, when presenting the update last month, Finance Minister Bill Morneau expressed no concern for continuing to run large deficits given the current economic outlook.

But concerns are valid. The latest forecasts from private-sector economists peg annual economic growth at only 1.7 per cent, according to the update. These forecasts are in fact more optimistic than the Bank of Canada, which estimates the economy will grow only 1.5 per cent.

In addition to the bleak economic forecasts, Statistics Canada’s recent monthly labour force survey estimated that the Canadian economy lost 71,200 jobs in November, the largest monthly job loss since the 2009 recession. This news comes on top of continued trade disputes and lagging business investment, all signs that the economy is headed for a downturn.

Clearly, the federal government can’t continue to ignore the warning signs of a slowing economy. It should limit discretionary spending now to lessen the risk of a serious deterioration in federal finances should a recession occur.

By Tegan Hill and Jake Fuss

Tegan Hill and Jake Fuss are economists with the Fraser Institute. This op-ed was coauthored by Milagros Palacios, a Fraser Institute economist.

www.troymedia.com