The federal government has announced billions in spending since the onset of Covid-19, leaving some wondering how the feds will pay for everything when the pandemic is behind us.
Since mid-March, the government has unveiled $146 billion in direct fiscal stimulus. The federal deficit for the year is now projected to exceed $250 billion, according to the parliamentary budget officer. Could this mean we’ll be facing tax hikes and austerity measures in the near future?
Not necessarily, according to a report from CIBC Capital Markets. Senior economist Royce Mendes compares the current crisis to previous recessions, and suggests that this year’s projected deficit may not lead to higher taxes or cuts to government services in the near term.
Canada entered the Covid-19 crisis with “the lowest central government debt-to-GDP ratio of the Group of Seven economies,” Mendes wrote. By comparison, when Canada was recovering from a recession in the mid-1990s, its debt-to-GDP ratio ranked sixth in the G7.
Mendes noted that the current low interest rate environment sets the current situation apart from previous government deficits. Currently, the federal government can fund its crisis response by borrowing for 10 years at a rate of 0.6%, Mendes said.
“Had the current government been operating in a situation where its benchmark 10-year bond yield was averaging more than 10%, as it was in the 1980s, there would be a huge cost in taking even a one-time hit to the budget deficit,” Mendes wrote.
Still, even with the government being able to borrow so cheaply, it’s possible the feds may introduce post-pandemic austerity measures. But Mendes noted that 2011 research from Olivier Blanchard, then the chief economist with the International Monetary Fund, found that “austerity could actually be self-defeating when attempting to lower debt-to-GDP ratios.”
Blanchard’s research, which focused on depressed economies, found that every dollar cut by governments reduced GDP by about $1.50, and every dollar of stimulus provided generated as much as $1.50 in GDP.
“As a result, it might cost more in terms of both GDP and the debt-to-GDP ratio to raise taxes or cut program spending too early,” Mendes wrote, adding that the cost of government inaction or introducing austerity measures too quickly “clearly outweighs any perceived benefits.”
“At some point, the federal government might raise taxes or cut program spending to create more room for the next downturn, but it doesn’t need to do so in the near term,” Mendes wrote.