MNI INTERVIEW: Canada Heads for Rate Trap on Unanchored Budget

Canada will likely present a budget Monday without a strong deficit restraint plan, leaving the economy vulnerable to a trap of slow growth and rising interest costs, former associate deputy finance minister Don Drummond told MNI.

Rock-bottom interest rates are bound to rise and could eventually drive up Canada's debt service costs toward an uncomfortable 15% of revenue according to Drummond, who now teaches at Queen's University and works with the C.D. Howe Institute on fiscal policy.

"Low interest rates are becoming part of the problem" by encouraging outsized debts in the public and private sectors, Drummond said. "When they do go up that's going to be a big problem."

Business groups have told MNI that ongoing deficits will likely go to less productive social programs and come after the economy has largely rebounded from the pandemic. Finance Minister Chrystia Freeland has said she will present a "historic" budget including more details on spending another CAD70 billion to CAD100 billion over three years to reshape the economy.

JOKE FISCAL ANCHOR

"We don't need anything like the 70 to 100 (billion), it's just uselessly adding to the fiscal debt," Drummond said of the spending goal. "It's not your garden variety recession, it doesn't need your typical bolstering of aggregate demand. It's a supply side shock essentially."

Drummond agrees with the government's hints about more childcare funding because that would boost the labor supply. Canada could also focus aid for the job market by making a CAD6 billion top-up to the national unemployment insurance fund, he said, which would avoid a sudden jump in payroll taxes.

The government isn't likely to restore any kind of strong "fiscal anchor," Drummond said. Minister Freeland had pledged a fiscal guardrail at some point tied to restoring 1 million lost jobs, but Canada has already regained most of those positions.

"It could be a joke of a fiscal anchor" like a debt-to-GDP ratio around the new peak set during the pandemic downturn, he said. That measure is weak because it ignores that fact that the total amount of debt also matters, Drummond said.

TRILLION DOLLAR DEBT

The federal debt is moving above a trillion dollars with deficits of CAD382 billion through the fiscal year that ended April 1 and another CAD121 billion this fiscal year. Freeland projected those figures in November without accounting for the extra economic rebuilding plans she said would be deployed over three years.

Restoring fiscal stability after the pandemic may be easier than the governing Liberal Party and some opposition leaders are suggesting, Drummond said. Doing so may require unpopular steps such as raising the federal sales tax or scaling back the rebuilding package, and the political climate isn't there yet, he said.

Canada could balance the budget by 2025-26 and prevent debt at all levels of government from reaching a record 100% of GDP by 2030, Drummond argued in a recent C.D. Howe paper.

Potential growth could be weighed down by the debt burden, an aging population and increased damage from climate change, Drummond said. "We are shifting down to a lower growth rate, and it's not being recognized, and it's not being incorporated into budget plans."