"The budget will balance itself"

During last year's election campaign, that little phrase uttered by Justin Trudeau was widely used in Tory attack ads, in an attempt to paint the Liberal leader as a feckless lightweight.  Like everything else the Tories tried, it didn't work, possibly because it was a remarkably selective edit of what Trudeau actually said. In a TV interview back in February 2014, Trudeau suggested that "the commitment needs to be a commitment to grow the economy, and the budget will balance itself".

Tories may affect not to believe that, but most economists would, and there's fairly recent evidence of it in Canada. Starting in the mid-1990s, the Chretien (Liberal) government finally got serious about Canada's chronic budget deficit and debt problems. Most people recall, or rather think they recall, that the deficit was eliminated through stringent spending cuts, but this is only a small part of the story.  By far the biggest contribution came from soaring revenues, thanks in large measure to the steady growth that the US economy achieved at the time in response to a stimulative stance on the part of the Federal Reserve. The Canadian economy grew, and the budget balanced itself.

This ancient history is worth recounting because we seem to be embarking on another trip down the same road, under the guidance of the Trudeau government.  During the election campaign, the Liberals differentiated themselves from the two competing parties by pledging to run "small" and "temporary" deficits in order to boost the economy.  "Small" was to mean less than C$10 billion a year, and "temporary" meant the budget was to be back in balance by the time of the next election, in 2019.

So much for that. To the surprise of almost no-one, it turned out that the fiscal situation the Liberals inherited was far worse than the Tories had claimed, and with oil prices still low, the situation has only gotten worse in the last few months.  Finance Minister Bill Morneau said this week that revenues this year will be $12 billion lower than anticipated, and that the budget deficit will be $18.4 billion -- even before the Liberals tack on the cost of their election promises. The deficit will fall only slowly after that, and any hope of getting back to a surplus position by 2019 has been abandoned. At best, the Liberals may be able to keep the Federal debt/GDP ratio from increasing, and even that is far from certain. That ratio is currently around 31 percent, as this very comprehensive set of fiscal tables from RBC shows.  

Morneau has made it clear that the Government believes cutting the deficit would throw the economy back into recession, which is almost certainly correct.  The real question is whether the planned new spending will indeed get the economy back on track, generating growth that will start the process of bringing the deficit back down again. If it doesn't work, Canada could embark on another period of massive and seemingly intractable Federal deficits, just as happened from the late 1970s to the mid-1990s.

This excellent article by the CBC's Don Pittis spells out the risks to Morneau's approach.  Pittis points out that the ever-present risk of another financial crisis could easily throw the government's projections off track at any time.  Moreover, the possibility of ever returning to a period of really rapid growth is dwindling, as labour force growth slows with the retirement of the baby boom cohort. Canada's abysmal productivity record rules out any chance of a helping hand from that quarter.

It's a sobering message, but we'll have to wait until budget day in late March to see whether Morneau and Trudeau are listening. This week's deficit announcement is obviously intended to get the bad news out of the way early.  Many media commentators are adding together Morneau's $18.4 billion and the originally-pledged $10 billion stimulus, and concluding that the actual deficit will be close to $30 billion.  The smart political move would be to come in with a number nearer, say, $25 billion, which in current circumstances would be greeted with a sigh of relief.  We shall see.