John Ivison: Chrystia Freeland’s fiscal update peers into the Truss trap

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Chrystia Freeland will unveil her fall fiscal update this week and the focus will be on whether she has thrown out the Liberals’ free-spending playbook.

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Two years ago, the new finance minister defended lavish program expenditure as a “fabulous opportunity to rebuild the country along more equitable, greener lines.”

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Low interest rates meant “these are things we just can’t afford not to do,” she said.

Cassandras who predicted that one day interest rates would rise again were ignored. The finance minister said, without a great deal of humility, that the terrors of the debt crisis of the mid-1990s were formative for a generation of Canadians, but she insisted that none of the factors that drove the country to the brink then held true in 2020.

Well, guess what? There is very little that is new in the world of economics — what has happened before will happen again.

The pain in the mid-’90s was so acute because interest rates were higher than nominal economic growth, meaning 36 cents in every dollar of revenue went to public debt charges.

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We are now “only” spending 10 cents or so of every dollar on the debt, but it’s the exact same situation that the Canadian economy now finds itself in again. The Bank of Canada’s overnight rate is heading toward four per cent, while its growth forecast is just one per cent.

Freeland has belatedly acknowledged that the days of through the looking glass economics are over. In a memo to cabinet colleagues, obtained by the Toronto Star, she suggested that any new spending will have to come from “internal reallocations.”

As a result, her fiscal update promises to be very different from previous Liberal documents that have cumulatively doubled the national debt to $1.2 trillion in the past seven years.

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In the short term, the deficit is likely to look much rosier than it has in recent times. The Public Accounts for 2021/22 have just landed and showed the budgetary shortfall was $90.2 billion — huge by historic standards but down from the $113.8 billion predicted in the April budget.

The first five months of this fiscal year even show a budgetary surplus of $3.9 billion, a combination of a 20-per-cent, inflation-fuelled rise in tax revenues and a 20-per-cent drop in program expenses as COVID-related measures expire.

The forecast by Randall Bartlett at Desjardins Economics is a $20-billion deficit for the current year.

But storm clouds are looming. For one thing, public debt charges rose by 52 per cent in the first five months of the fiscal year, in tandem with interest rate hikes. Last year, the government spent $24.5 billion servicing the debt; Desjardins forecasts debt charges of $49.8 billion next year. So much for “We can’t afford not to.”

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The government’s sole fiscal anchor, the debt-to-GDP ratio, is likely to fall toward 40 per cent, rather than rise to the 66-per-cent level of the ’90s, assuming Freeland lives up to her promise that 50 per cent “is a line we shall not cross.”

More worrying for the government will be the warning from Desjardins and others that the prospect of a recession will increase future deficits and spark an increase in unemployment.

All of which points to a change in the trajectory of spending — not to austerity, but at least to prudence, where paying $7,300 for a suite at the Corinthia Hotel in the heart of London is considered not only ill-advised but unethical.

Sahir Khan, executive vice-president at the Institute of Fiscal Studies and Democracy at the University of Ottawa, said this is a third-term government that is in danger of eroding public confidence in its stewardship of the public purse. “How they spend resonates with Canadians,” he said.

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He pointed out that committing to spending cuts and enacting them are two different things. “Every spending measure has a constituency,” he said. “It will be interesting to see if they really mean it.”

The problem with all governments is that budgets tend to creep upward, not abate. The Liberals discovered that the only way to reform Indigenous job training was to increase funding by $100 million, so that it did not risk political fallout when recipients were deprived of funding. Prudence is unlikely to go down well with the Liberals’ supply-arrangement partners in the NDP, or with progressive voters who are still waiting for the Liberals to live up to many of the $78 billion in new spending commitments in their election platform last year.

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But Freeland no doubt watched anxiously as the international capital markets recorded their verdict on the U.K.’s mini-budget, with its unfunded tax cuts.

Investors judged the Truss government’s plan was not fiscally sustainable, sending bond yields rocketing and the currency into freefall. As The Economist noted, in Britain, the reactions of focus groups have been subordinated to those of bond markets.

Not before time, Freeland may be coming around to old ideas like sound money that were formative for a generation of Canadians and remain just as relevant today.

• Email: jivison@postmedia.com | Twitter: IvisonJ