Federal budget will make it harder for Bank of Canada to fight inflation

Ottawa has indicated it remains more committed to delivering new social programs than fixing fiscal damage

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Finance Minister Chrystia Freeland could effectively tell the Bank of Canada that she alone is battling inflation when she presents a budget on Thursday that is expected to be filled with new spending initiatives.

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Ahead of the release, Prime Minister Justin Trudeau’s government has signaled that it remains more committed to delivering new social programs than to repairing the fiscal damage caused by the pandemic or cooling an overheated economy.

The Bank of Nova Scotia predicts that Freeland will put the government in the red by another $40 billion over the next five years, despite a surprise increase in revenue.

This will contrast sharply with the Bank of Canada’s decision next week, when officials are expected to make the first 50 basis point hike in the key interest rate since 2000, as they seek to pare gains in consumer prices from a three-decade high.

By the time Freeland releases its 2023 fiscal plan a year from now, markets and economists expect the central bank to have hiked borrowing costs by almost three percentage points — one of the most aggressive bullish cycles in decades. decades.

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“The budget will likely strengthen our outlook that monetary policy will have to shoulder the brunt of controlling inflation,” Rebekah Young, Scotiabank’s head of fiscal economics, said in a statement to investors.

Young puts potential new spending through 2027 at around $140 billion to incorporate both Liberal campaign promises and program costs associated with a power-sharing deal Trudeau struck with the left-leaning New Democratic Party. . This will only be partially offset by windfall revenues from inflation and rising oil prices, as well as new taxes, which Scotiabank predicts will generate $100 billion in revenue.

Prime Minister Justin Trudeau speaks at a press conference in Ottawa.
Prime Minister Justin Trudeau speaks at a press conference in Ottawa. Photo by REUTERS/Patrick Doyle/File Photo

However, the government may exercise more restraint by slowly rolling out new programs or funding new measures with money reallocated from other programs.

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“I can see them taking a more cautious approach that’s consistent with the supply-shock inflationary environment we find ourselves in,” Kevin Page, chief executive of the Institute for Tax and Tax Studies, said over the phone. democracy from the University of Ottawa. This could include “reallocations to maintain the spending line and a commitment to review existing program policies.”

Freeland will also try to frame the new spending as pro-growth, which would make it easier to justify in an economy struggling with capacity. Otherwise, economists will say that deficits will simply translate into higher interest rates, which will force the country’s indebted households to pay the price for expansionary government policy.

Not that economists are immediately worried about Canada’s financial situation.

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The basic outlook is for strong growth in the foreseeable future that will allow the government to take on all of the new debt. Corporate and household balance sheets are strong, and the country’s commodities sector acts as a buffer against headwinds from Russia’s invasion of Ukraine, which has driven up the prices of everything from oil to fertilizer.

The job market is hot and companies are showing signs of starting to invest again. Inflation helps, rather than hurts, public finances.

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But economic risks are beginning to trend to the downside and Canada is much more vulnerable to a future crisis, with the possibility of impending stagflation.

Debt has doubled under Trudeau, while spending shifts from transitional, one-time measures to counter the COVID-19 pandemic to new, permanent social programs like child care and dental care.

There are also medium- and long-term risks that have yet to be considered, including wartime pressure to increase defense spending and provincial demands for increased health care funding.

All of this will eventually take the federal government beyond what is sustainable without possibly raising taxes or cutting existing spending.

“Freeland needs to start having an adult conversation with Canadians about government priorities,” said Chris Ragan, director of the school of public policy at McGill University in Montreal, over the phone. “No one is talking about how to get the fiscal framework back in shape for the next big event that will hit us. As the past six weeks have demonstrated, there is always something serious happening to us around the corner.”

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The accumulation of more deficits, meanwhile, threatens a further erosion of government credibility. Trudeau’s failure to stick to promised deficit trajectories or fiscal rules — sometimes called fiscal anchors — predates Freeland’s taking over as finance minister in August 2020.

The Bank of Canada building in Ottawa.
The Bank of Canada building in Ottawa. Photo by REUTERS/Chris Wattie/File Photo

However, the government is once again struggling to keep its commitments. Only four months ago, Freeland pledged “joint responsibility” to keep inflation at its 2% target when it renewed the Bank of Canada’s mandate for another five years.

Last year, the finance minister budgeted $100 billion in additional stimulus over three years to spur growth, but pledged to tie spending to slack in the labor market. Now that the economy is at full employment, the government does not seem willing to reduce it.

On Thursday, the government will recommit to at least one fiscal target: to keep the national debt as a percentage of gross domestic product on a downward path.

Debt-to-GDP anchors in times of rapidly rising prices, however, offer little discipline. They could even be counterproductive by allowing governments to spend under inflationary conditions.

“There’s definitely a tax calculus coming up and you have to adjust expectations of what’s possible,” Page said.

Bloomberg.com

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