MNI: Canada Deficits Leave Room For Flexible BOC-Ex-Officials

Canada’s budget deficits will remain elevated on an expensive NATO spending target and business investment supports, former officials told MNI, though stimulus is modest enough to avoid tying the central bank's hands at a time of weak growth and sticky core inflation.

Stronger fiscal anchors are needed in coming years to bring the budget back towards balance and prevent weak government productivity from dragging the economy, former officials said. Prime Minister Mark Carney's Nov. 4 budget abandoned a goal of lowering debt-to-GDP and focused on a similar measure for the deficit. 

“What’s important with a fiscal anchor is to have one but also to keep the same one over time,” Yves Giroux, who finished a term as Parliament's budget officer in September, said in an interview. “Having a fiscal anchor that changes every year, or regularly, it defeats the purpose.”

Carney's goal of doubling military spending to 5% of GDP by 2035 is just the start of pressures like past commitments to boost healthcare and other social programs, he said. “It’s a lot of demands at the same time, so that’s probably why the fiscal anchors are less constraining than they could be,” Giroux said.

The new interim budget officer said last week Carney's deficit anchor has less than a 10% chance of being met given higher spending and a weak economy.

SPACE TO TACKLE PROBLEMS

Deficits to Giroux remain in line with the BOC's stance that the Oct. 29 cut to 2.25% will be the last if its forecast holds up for inflation to remain around 2%. Governor Tiff Macklem says higher costs from U.S. tariffs and supply-chain damage should be offset by weaker Canadian growth. 

This year's CAD78 billion deficit is a record in cash terms outside Covid but only 2.5% of GDP. Carney's deficit "is nothing like what we saw in the Covid period,” Giroux said while attending a Macdonald-Laurier Institute conference. (See: MNI INTERVIEW: Supply Damage Supports BOC Hold- Dal's McNeil)

Macklem has flexibility to work independently because the policy rate is well above zero, former top finance department official and MLI analyst Tim Sargent told MNI.

“The Bank has the monetary space to deal with its problems; however, the Trump shock is a structural issue that is best left to fiscal policy to deal with, and to be fair the government is taking it on," he said. "What we need to guard against is mistaking a supply shock for a demand shock, which is what happened under Covid.”

Spending to protect Canada from U.S. trade policy must shift in the medium term towards a balanced budget, the only anchor voters understand, Sargent said. “The problem with things like debt-to-GDP is you don’t control the denominator. So it can bounce around and that bounces your target around." 

TYING THE GOVERNMENT'S FEET

Another target worth exploring is for raising incomes or living standards, former finance assistant deputy minister and BOC research manager Jean-Francois Perrault said during the MLI conference. He also said Carney moved towards a welcome focus on investment.

“There’s a clear shift in priorities away from the operational stuff,” Perrault said, even if Carney's goal of unlocking a trillion dollars of new investment is somewhat unrealistic. Perrault is now chief economist at Scotiabank, which sees the Bank on hold through early 2026 and its next move a hike. 

Canada's lagging productivity comes from low private investment but also public sector weakness, former officials said. Keeping corporate taxes low to draw investment creates another barrier to fixing the deficit, they said, but there's room to make government more efficient during Carney's plan to cut 10% of federal workers.

Historical and international comparisons show Canada's public sector lagging, former Statistics Canada chief Munir Sheikh told the conference. “We need to have some anchors which will tie the feet of the government to economic principles,” he said. Departments without restraints seek expansion no matter what their outputs are, he said. 

Despite the government's commitment to fiscal restraint Sheikh said the abandonment of past goals when things got tough means that now “we don’t have fiscal anchors.”