Growth, Prudence, Politics: The Tests Ahead for Carney’s First Budget

As published in Policy Magazine

Over the past week, I’ve received a number of calls from journalists asking about the federal government’s upcoming Nov. 4th budget. How to frame it. Why it matters.

All indications are this could be a consequential budget for Canada. So, here’s a framework I’m using to think it through.

One way to look at the budget is through three dimensions, or three accountabilities.

There is political accountability. A government must earn parliamentary consent for its agenda. In a minority setting, this is a matter of survival.

There is fiscal accountability. Essentially; how to finance the government’s agenda, as well as the existing stock of debt inherited by the government. This is where the numbers come in: the size of the deficit, the path of debt, revenues, and the credibility of the plan to markets.

And there is economic accountability, which concerns how the budget shapes the country’s long-term outlook and affects the living standards of Canadians. A federal budget is one of the few instruments that can genuinely shift the direction of the economy.

All three dimensions interact closely, but often one becomes the dominant lens. Sometimes it is political, as in 2006. Sometimes fiscal discipline takes centre stage, as in 1995. This year, Mark Carney — in keeping with the credentials that helped get him elected — is putting the emphasis on the economic, though he will need to navigate the politics as well.

Carney has framed his agenda around the urgent need to transform the nation’s economy at a time of crisis, and I have written elsewhere about his theory of the case for stronger, investment-driven growth. The overarching goal has drawn broad public and stakeholder support, even if there is still plenty of debate about the methods and approach.

We will soon see what specific levers Carney will pull to get us there. Options include everything from putting up cash upfront to de-risk major private projects, to tax measures or using Crown corporations or special operating agencies (SOAs) to make investments.

Credibility is important because without it, efforts to bolster growth become impossible. If markets punish Canada for its debt, interest rates could surge.

But by all accounts, the agenda will be expensive and will need to be financed, which brings us back to fiscal accountability and the central question for Finance Minister François-Philippe Champagne, which is: how can the government ensure the fiscal track remains sustainable without handcuffing its ability to use a critical tool to alter the country’s economic trajectory? In other words, can Canada design a plan that delivers both prudence and growth, both fiscal and economic accountability?

This is where it gets a bit wonkier.

Credibility is important because without it, efforts to bolster growth become impossible. If markets punish Canada for its debt, interest rates could surge.

To prevent that, governments try to establish credibility through fiscal anchors, or guardrails, that demonstrate their finances are on a sustainable track. Some anchors are technical; others are simple and blunt. Moving the budget toward balance over a certain period — the anchor of choice for nearly a decade until 2015 — is a basic type of fiscal anchor. The Trudeau government preferred using the debt-to-GDP ratio.

The Business Council of Canada, where I work, has proposed a dashboard of such anchors for the Carney government to adopt. Informed by an extensive consultation with stakeholders over the summer, we recommend three in particular: a long-term sustainability anchor such as a declining gross-debt-to-GDP ratio, an early-warning indicator focused on debt-service costs, and operational rules like a clear deficit-reduction target.

We believe these are sensible foundations for accountability. But one criticism of conventional fiscal anchors like the ones we propose is that they may focus too narrowly on deficits and debt ratios, and risk underplaying the growth side of the equation.

This appears to be where the Carney government finds itself. Some of these conventional metrics, like a stable or declining debt-to-GDP ratio, may be difficult to meet under its ambitious agenda. At the same time, the government doesn’t want to spook markets.

So, it’s introducing a new framework to signal discipline, shifting the emphasis from debt dynamics to the quality of spending. This is reflected in guidance from the IMF’s latest Fiscal Monitor, which advises economic growth via “enhancing the efficiency and composition of public spending”.

The argument is that debt is less concerning when it funds investments that raise productivity. And this government plans a lot of investments.

And to reinforce that idea, they have pledged to balance the so-called operating budget while running deficits only for capital spending.

Some people like the framework. Others don’t. The risk is that such flexibility can be abused. Ministers could be tempted to relabel ordinary spending as investment, creating deficits without the economic payback.

Scotiabank Economics has proposed a novel approach to strengthen the credibility of the government’s capital-budgeting model: anchor fiscal policy to a GDP-per-capita growth target.

All smart ideas. But there is no single perfect guardrail. Which is why a system of anchors or guidelines — including quality-of-spending tests proposed by the government — is preferable.