Instead the focus should be on enacting an economic and fiscal policy that, drawing from the evidence from the United Kingdom and Canada’s own experience in the mid-1990s, prioritizes deficit reduction and balanced budgets.
By Sean Speer, Sep. 16, 2016
The Trudeau government’s economic and fiscal policies received a big boost during the visit to Ottawa earlier this week by International Monetary Fund (IMF) managing director Christine Lagarde. Her desire to see Liberal policies “go viral” was interpreted as a major endorsement of Trudeau’s deficit-financed stimulus spending. Debts and deficits are now seemingly the rage.
Yet the IMF’s confidence in fiscal policy has been misplaced before. Its Keynesian predisposition was proven spectacularly wrong by the positive economic effects of the United Kingdom’s “austerity” program. The Canadian government should therefore heed Lagarde’s policy advice with real caution.
The lessons from the United Kingdom are salutary in this regard. The country is better off that the Cameron government chose to ignore the IMF’s calls for more spending, deficits and debt.
Debts and deficits are now seemingly the rage.
Recall that the U.K. Conservatives inherited a ballooning deficit and rising national debt when they were elected in 2010. The budget deficit peaked at £150 billion (or more than 10 per cent of GDP) in 2009–10 and more than £1 trillion has been added to the national debt since 2005. It’s no wonder that the outgoing junior finance minister left a letter for the Cameronites that simply read “I’m afraid that there’s no money.” In the eyes of most economists and policy commentators, something needed to change.
Except, not in the IMF’s eyes. It warned that a focus on deficit cutting was “playing with fire” and instead called for “loosening the fiscal straitjacket” that the government was purportedly imposing on the U.K. economy.
The Cameron government, to its credit, disregarded this admonishment and largely stuck to its plan to reduce the country’s massive deficit. In so doing, it was partly influenced by Canada’s successful experience with deficit reduction and fiscal reform in the mid-1990s. The result is the United Kingdom’s deficit-to-GDP ratio has fallen by roughly two-thirds and the economy is experiencing world-leading growth. There’s still more work to be done — the budget deficit still nags, for instance — but the general trajectory has been positive and paid positive economic dividends thus far.
And the IMF had to admit it was wrong. As Lagarde conceded in 2014: “We got it wrong. We acknowledged it. Clearly the confidence building that has resulted from the economic policies adopted by the government has surprised many of us.”
Which brings us back to Canada and the IMF’s renewed calls for stimulus spending to kickstart the economy.
The Trudeau government has been using the IMF’s fiscal playbook thus far. Its March budget warned that “a country can’t cut its way to prosperity” and that we needed to heed the IMF’s call to “make use of available fiscal room.” That’s how we got $120 billion in accumulated deficits over the coming years in the name of “growth” rather than “austerity.”
And what has it gotten us to date? Sluggish economic growth, stagnant job creation (mostly concentrated in Toronto and Vancouver) and declining business and consumer confidence.
Deficit reduction and balanced budgets can provide the fiscal foundation of a macroeconomic policy that sends a signal to investors about the stability of the economy in the short and long term.
The Canadian economy is sputtering and there’s little evidence that more deficit spending is the solution. Quite the contrary. A new analysis by Macdonald-Laurier Institute senior fellow Philip Cross warns that deficit spending may be discouraging business investment and thus exacerbating the problem. As Cross puts it: “the real macroeconomic message from the data on the Canadian economy — and for that matter its neighbour to the south — is that years of unprecedented monetary and fiscal stimulus have yielded increasingly fewer returns in growth.”
The right fiscal policy response then is not more deficits and debt, notwithstanding Lagarde’s prescription. The lesson from the U.K. is that sound public finances are key to a pro-growth agenda. Deficit reduction and balanced budgets can provide the fiscal foundation of a macroeconomic policy that sends a signal to investors about the stability of the economy in the short and long term.
As the parliamentary session resumes next week, the focus should be on enacting an economic and fiscal policy that draws from the evidence from the United Kingdom and Canada’s own experience in the mid-1990s. This means politely declining the IMF’s advice.
Sean Speer is a Munk senior fellow at the Macdonald-Laurier Institute.