Like many countries, Canada has opened the spigots on spending to help cushion the economic impact of the Covid-19 outbreak.
Now, as the economy begins restarting, it’s critical that policymakers plan out a return to fiscal stability and commit to maintaining low, stable inflation, says the C.D. Howe Institute.
A report from the Toronto-based think tank’s Covid-19 crisis working group said that, while the federal government rightly abandoned its fiscal anchors to address the immediate, severe effects of the pandemic, Canada will emerge from the first wave of the crisis with very high public and private debt levels — and will be increasingly dependent on investors to finance that debt.
As a result, the working group said it will be critical to maintain investor confidence so debts can continue to be financed “at a reasonable cost.”
To that end, it said, “measures to stabilize finances and restore fiscal sustainability in the medium to long-run are critical.”
If the economic recovery proves sluggish as the economy starts reopening, there’s a risk that temporary, emergency programs will become viewed as more permanent, “turning one-off deficits into structural deficits”.
“Should that be the case, investors will become concerned with fiscal sustainability, Canadian dollar denominated debt will become riskier, and borrowing costs could increase rapidly,” the report noted.
To mitigate that risk, the report recommended that governments set out how they intend to wind down the temporary support programs that were adopted in the face of the pandemic, “as part of a transparent plan to stabilize public finances over the medium term.”
The group also recommended that if the country faces a second wave of Covid-19, comprehensive lockdowns should not be repeated.
“Placing the economy in a partial coma made sense during the first wave of the pandemic, but if there is a second wave, a second economy-wide shutdown should be avoided in favour of more targeted approaches that are effective and avoid further erosion of public finances and the risk of hitting debt walls and loss of borrowing capacity,” it said.
Additionally, the report indicated that, on the revenue side, governments will likely need to look beyond tax hikes to ensure a return to more sustainable finances.
Longer term, the revenue-sharing arrangements between the various levels of government (federal, provincial and municipal) should also be reviewed, the report said, “to promote a closer alignment of revenue generating powers with the delivery of public services.”
Alongside fiscal rehabilitation, the report also stressed the importance of reaffirming Canada’s low and stable 2% inflation target.
By recommitting to the inflation target, the Bank of Canada “would retain ample latitude to increase its balance sheet over the next couple of years to support the economy and the financial system in a deflationary environment but provide assurance that it will promptly move to deal with any inflation that may emerge later as global supply chains are reorganized,” it said.