A drop in government spending in 2013 will act as a drag on real GDP growth, resulting in weaker economic performance than the Bank of Canada is forecasting, according to a new report from CIBC.
The bank’s latest Canadian Employment Insights Report examines spending projections included in the federal budget and those of the four largest provinces. It estimates that real government spending will decline by 0.9% in 2013/14, which it says will have a roughly 0.2 percentage-point drag on real GDP growth.
This is in contrast to the Bank of Canada’s projections, which suggest that government spending will boost economic growth by 0.3% next year.
“Just as we warned that the Bank was too optimistic in its initial 2012 call, its 2013 forecast also looks to be counting its government spending chickens well before they will be hatched,” says Avery Shenfeld, chief economist at CIBC.
“The Bank’s forecast could be about 0.5 percentage points too high, enough to make the difference between growth being above potential, requiring interest rate hikes, or as in our forecast of 2.0% growth next year, not fast enough to narrow the output gap and call for monetary tightening.”
Declining government spending will likely be a theme that impacts the economy beyond 2013, the report adds. A longer-term look at government spending suggests that we have yet to complete the full wind-down from the recession-related jump in government’s role in the economy. Nominal government spending on goods, services and capital investment is running about 1.5% above its historical average share of GDP, and even further above where it stood in the last cycle.
However, the federal and provincial governments are committed to additional spending cuts in an effort to reduce deficits.
“There is still a significant pinch to economic growth associated with budget belt tightening,” says Shenfeld.
In the current 2012/13 fiscal year, the report notes, nominal GDP growth hasn’t quite lived up to expectations. But it says next year will likely present an even greater challenge.
“We see Canadian real GDP limping ahead by just 2% next year,” says Shenfeld.
Still, compared to what is happening in other jurisdictions, Canada remains in an enviable position, he adds. Europe and the U.S., for instance, are facing far more alarming debt levels.
“Having started from a combined federal/provincial deficit of only a third of that stateside, there’s no equivalent threat of an outright recession being induced by cuts coming from Ottawa and the provinces. We’ll get through our fiscal drag much sooner than the U.S. with a lot less pain in total.”