How Carney should anchor his deficit spending

As published in The Hub

On Nov. 4, Prime Minister Mark Carney’s government will table its first budget, one that will argue for the continued use of fiscal policy as an instrument of growth.

Carney has been clear he plans to run ongoing deficits to fund investment. Many other countries, after all, are using fiscal levers aggressively to gain economic advantage. And there is no path to fiscal sustainability without growth, he will argue.

The counterpoint is that borrowing to fund the Carney agenda is being layered onto a baseline already stretched after a decade of heavy spending and deficit accumulation. This comes on top of long-term pressures from new defence requirements and structurally weak growth. These fiscal pressures are raising widespread worries about deficits and debt that could erode credibility and drive up borrowing costs.

In anticipation of Carney’s consequential budget, the Business Council of Canada conducted an extensive consultation on the future of the country’s fiscal policy, co-chaired by myself and Serge Dupont, a former deputy clerk of the Privy Council.The process brought together the voices of more than 50 chief executives and nearly 20 respected economists, investors, and policy experts. The goal was to produce a comprehensive snapshot of how Canada’s most engaged economic stakeholders view the state of federal public finances, the role of fiscal anchors, the balance between investment and restraint, and the steps needed to restore credibility in fiscal management.

While there is diversity of opinion, our research found broad consensus on some fundamental points.

What we heard

First, growth is the foundation of sustainable fiscal policy. Without it, there is no path to sustainability. Our consultations found some backing for public investments and efforts to “catalyze” private capital in large infrastructure projects. A majority of chief executives said that while they are concerned about the state of the nation’s finances, they would be somewhat tolerant of higher government borrowing if it finances “economy-enhancing” initiatives. There is also broad agreement that, within the frame of wider tax reform, taxes on investment should be reduced to attract capital.

Second, credibility matters. While the country’s fiscal starting point is fragile, we’re nowhere near a crisis. There is fiscal capacity for the government to use in the short-term. At the same time, a credible and sustainable fiscal plan is critical to maintaining investor confidence in the economy.

Third, most analysts we spoke with agreed the government should undertake a more rigorous, principles-based program review. This would mean asking fundamental questions of every program: Should the government even be in this space? If so, is it something the federal government should do, or could a province do it better? And if it is a federal role, could it be delivered more efficiently? To achieve the scale of savings envisioned by Carney, such a review would probably also need to include transfers to persons and provinces.

Finally, there is an overwhelming demand for credible fiscal anchors to instill political discipline. Most respondents favoured a dashboard of metrics rather than a single rule. A stable, or ideally declining, path for debt-to-GDP was the most frequently cited anchor. Many also pointed to debt-servicing costs as critical, since over time they can crowd out program spending. The most hawkish called for balanced budgets or large primary surpluses to bolster market confidence.

One message from respondents was that discipline inside government has weakened since the pandemic, necessitating more concrete operational tools alongside the technical anchors preferred by economists. Experts feel the institutional “muscle memory” for fiscal restraint, forged in the 1990s, has atrophied. The result is a system where the default path is to spend.

That is why many stakeholders, particularly those with government experience, have a preference for a practical framework that combines long-term sustainability measures with short-term operational rules that ministers and officials can actually manage against.

History shows that simple targets, set over short-term horizons, work best. To bring Canada’s finances under control in the mid-1990s, Paul Martin adopted two-year horizons for his fiscal targets, including a pledge in his first budget in 1994 to halve the deficit as a share of GDP by 1996. At the G20 summit in Toronto in 2010, just after the global recession, Prime Minister Stephen Harper led a group of advanced economies to commit to halving their deficits within three years.

In the current context, operationally straightforward rules, such as halving the deficit within three years—the Business Council’s core recommendation for Carney—can provide a fiscal path that is easy to measure and enforce.

Putting it all together, a well-designed framework would be multi-faceted. It would combine a long-term sustainability anchor such as a declining gross debt-to-GDP ratio, early-warning indicators such as interest-to-revenue or interest-to-GDP ratios, and short-term operational rules—for example, a deficit reduction target or spending cap—that are easily understood and can be implemented by ministers and the public service.