Canadians must lose irrational fear of increased deficits, economist says

As Canada’s finance minister consults widely in preparation for the next federal budget, an urgent question on every economist’s mind is: Should the federal government increase its spending to help the Canadian economy?

No empirical support for belief higher spending increases inflation, interest rates: Louis-Philippe Rochon

Canada's Finance Minister Bill Morneau is consulting widely in preparation for the next federal budget. (Chris Wattie/Reuters)

As Canada's finance minister consults widely in preparation for the next federal budget, an urgent question on every economist's mind is: Should the federal government increase its spending to help the Canadian economy?

Such a question undoubtedly sends chills down the spines of many Canadians, who have an almost irrational fear of increased deficits. Many labour under the illusion that spending will somehow lead to higher inflation and higher interest rates. Yet there is no empirical support for such fears.

These concerns lead many to argue that fiscal policy is inefficient and the government should reduce spending or risk jeopardizing the recovery. Proponents of reduced spending argue there are good economic reasons to pursue more austerity in the name of sound finance.

But there is no valid economic rationale for austerity. In fact, the growing consensus today is that austerity is wrong and does harm. The IMF now supports this claim, having argued recently that the idea of austerity has been largely "oversold." This suggests that the only possible reason for promoting austerity is political, not economic.

The truth is that the last decade has not been kind to the Canadian economy. We have had, on average, mild growth, and prospects for the next few years are not encouraging. The IMF has recently downgraded growth prospects for Canada for the next two years, and the more we remain in dismal growth territory, the more it costs the Canadian economy in the long run.

Chances of economic revival stand and fall with the Trudeau government injecting massive spending into the economy.

And by massive, I mean massive.

Our current deficit is projected to be between one and 1.5 per cent of GDP. By historical standards, that is quite low. For instance, at the heart of the crisis, Canada's deficit-to-GDP ratio was "only" 3.5 per cent. Yet it had an immediate and positive effect: it stopped our downward spiral, and for a moment, the Canadian economy stabilized. By 2010, however, the federal government reverted back to austerity, and this is when the Canadian economy began to stall.

In the U.S., the deficit-to-GDP ratio was 9.89 per cent in 2009 and 8.65 per cent in 2010. It is little wonder why the U.S. outperformed the Canadian economy in terms of recovery. This suggests that governments can always spend more, and nobody can say that these deficits contributed to inflation or to high interest rates.

But the current government's spending is grossly inadequate. To have an impact, the government must commit to considerably more spending. I would argue that it should be prepared to increase our deficit-to-GDP ratio to around five per cent. By historical standards, this is not unprecedented. In fact, what is unprecedented is that we are still caught in the lingering effects of the 2007-08 crisis almost a full decade after it began.

What we must understand is that we are living in an era of "depression economics." All the standard tools of analysis that economists have used over the last three decades are no longer relevant (if they ever were). In fact, current economic thinking is broken, and the last three decades of market-friendly policies such as lower taxes, privatization and liberalization have proven to be a colossal mistake that will take generations to repair. We must fall back on tools that have proven themselves in the past and that will prove themselves valuable again now. This begins with fiscal policy.

And those who claim deficits create inflation or place our children in debt are wrong. These are myths that do not hold in the real world. Fiscal policy and deficit spending create jobs, create wealth, create growth. These are some very basic and proven facts about economics.

Louis-Philippe Rochon is a professor at Laurentian University and co-editor of the Review of Keynesian Economics.