Bank of Canada Governor Stephen Poloz’s decision this week to talk about fiscal policy deserves some more attention.
Central bankers tend to avoid the political realm. But cross-border incursions are becoming necessary because the political discourse around fiscal policy is stuck in the early 1990s, a very different time from the post-crisis era we are in now. Economic stability for the foreseeable future could depend on the fiscal and monetary authorities working in concert, not independently, as has become their habit.
Poloz avoided explicitly telling the new Parliament and the provinces what to do. Instead, the central bank let it be known that fiscal stimulus would be preferable to interest-rate cuts at this juncture. In effect, policy makers offered politicians a choice: they can do their part in offsetting the damage caused by the trade wars, or they can leave it to the central bank and risk setting off Canada’s household-debt bomb.
“There is a choice there about what pile of debt you want to increase,” Carolyn Wilkins, Poloz’s top deputy, said at a press conference.
The Bank of Canada left interest rates unchanged on Oct. 30, even though it dropped its forecast for economic growth next year to 1.6 per cent, slower than the current Goldilocks rate of 1.7 per cent, the maximum the economy likely can grow without stoking inflation. Poloz told reporters that the Governing Council considered an insurance cut, but decided the risks of re-igniting a household borrowing binge were too great. Policy makers said specifically that fiscal policy will be one of the variables that will determine whether they go through with a cut in the months ahead.
“Poloz’s comments on fiscal policy put even greater attention on the Liberal minority government’s plans going forward,” Simon Deeley and Mark Chandler of RBC Capital Markets advised their clients in a note on Nov. 1.
The Bank of Canada’s next two policy announcements are Dec. 4 and Jan. 22. Prime Minister Justin Trudeau said he would announce his new cabinet on Nov. 20. The central bank typically waits for fiscal measures to be approved before working them into its forecasts, so it could be the new year before Poloz knows how much help he should expect from federal politicians.
“It’s obvious that none of us has much room to maneuver, and some central banks have literally none left,” Poloz said in an interview with BNN Bloomberg after the interest-rate announcement. “This is when fiscal policy is most powerful and monetary policy is the least powerful. We’ve known that for a really long time. This is not a revelation.”
It might be a revelation to some members of Canada’s political elite.
Alberta’s new United Conservative government has decided that erasing a $9-billion deficit in four years is the best thing it can do for the province’s fragile economy, even though debt is only about 12 per cent of GDP, the lowest in the country.
The world has changed and fiscal frameworks must be reviewed as well
Ángel Ubide, head of economic research at Citadel LLC
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Conservative Leader Andrew Scheer directed his 201,386 Twitter followers to an “important read” on fiscal policy in the Financial Post by Gwyn Morgan, the former chief executive of Encana Corp. and a member of the Order of Canada. Morgan lamented Trudeau’s deficits, saying the budget shortfall “leaves no financial room for a recession.” He drew parallels with Pierre Trudeau’s tenure as prime minister through the 1970s and early 1980s, when “immense public spending overheated the economy, resulting in runaway inflation.” And he said Canada’s economy had become “dependent” on “ever bigger government spending,” necessary because so many other policy choices “discourage private investment.”
Quarterly investment in non-residential structures and machinery and equipment has hovered around nine per cent of GDP since the start of 2016, down from a peak of almost 12 per cent at the end of 2014, but better than the eight-per-cent average since 1961, which is as far back as Statistics Canada data goes.
Anecdotal evidence suggests that excessive regulation has weighed investment, but not as much as the collapse of oil prices five years ago, generally weaker global demand, U.S. President Donald Trump’s trade wars, and the shift to the digital economy, as companies can enhance competitiveness by renting space in the cloud instead of buying hardware and building factories.
Morgan also exaggerates the threat posed by current government borrowing. This isn’t the 1970s. The interest that countries such as Canada pay are stuck at low levels and there is little reason to fear a surge to the double-digit rates that pushed the country to the edge of debt crisis in the early 1990s. Demographic changes and evolving investment strategies should keep downward pressure on interest rates, and central banks have learned how to contain inflation.
That means there is more scope for governments to borrow than we might have thought a couple of decades ago, when we were getting comfortable with the idea that monetary policy could manage the business cycle and fiscal policy would determine the economy’s ability to generate wealth over the longer term. That view didn’t put enough weight on the possibility that investor sentiment and financial flows could make interest rates and inflation structurally low. The IMF found that developed economies should be fine if their debt servicing costs are below 15 per cent of GDP; Canada’s public debt charges currently are about one per cent of GDP, compared with 6.5 per cent in 1991.
“Fiscal policy rules have focused, in an asymmetric manner, on reducing debt and deficits, almost regardless of the cyclical position of the economy,” Ángel Ubide, head of economic research at Citadel LLC, the Chicago-based alternative-asset manager, wrote earlier this year. “The world has changed and fiscal frameworks must be reviewed as well.”
Ubide thinks central banks and finance ministries could achieve better outcomes by co-ordinating. Poloz signalled that he’d like to try to get the policy mix right. He told BNN Bloomberg that $5-billion of fiscal stimulus is equivalent to a quarter-point cut to interest rates.
The Liberals and the Conservatives both proposed tax cuts worth about $6-billion per year. It looks like Parliament can take over from here.