Public policy in Canada remains haunted by large deficits that prevailed in the 1980s and early 1990s. With COVID-19 economic response pushing the federal deficit to an estimated $343 billion in 2020/21, some pundits are starting to beat the deficit hysteria drum again.
Don’t let big numbers scare you. Here’s why we shouldn’t be worried.
What really matters is the size of a country’s debt to its economy or GDP. By that standard, even the jump up in federal debt from 31% of GDP in 2019/20 to 49% this year only puts us back where we were in 2000, and nowhere near the 110% of GDP at the end of World War II.
In other words, we have a long way to go before anyone needs to be concerned. In comparison to other G7 countries, Canada’s debt-to-GDP ratio is the lowest by far.
Another way of looking at this is the federal government’s debt service costs, currently about 7% of federal revenues, way down from a peak of 38% back in 1990/91. Debt service costs are a function of the size of debt and interest rates, and while the former has grown the latter are very low. In fact, the feds expect to save $4 billion in public debt charges this year due to low interest rates.
The federal government is actively shifting more of its bond sales to longer maturities to lock in those low interest rates. The interest rate on ten-year bonds is 0.8%, compared to 2.7% at the time of the 2019 budget. Three-month T-bills are paying merely 0.5%.
This situation is very different from the 1990s when interest rates were very high, part of a misguided attempt then by the Bank of Canada to bring inflation close to zero, which also plunged the economy into a deep recession.
In normal times, deficits are financed by the sale of bonds to banks and individuals. The vast majority of these buyers are Canadian, with only a small percentage sold to foreigners. This is convenient because people like to have safe assets to invest in as part of their portfolios.
In the COVID response, the Bank of Canada has stepped up with a program of purchasing up to $5 billion per week of federal government bonds, which helps suppress interest rates and stabilize bond markets. The federal government still pays interest on those bonds to the Bank of Canada, but at the end of the year the Bank remits its profits back to its owner, the federal government.
Some commentators are smearing this perfectly legal operation as running the printing presses, invoking images of 1930s hyperinflation in Germany when people moved through the streets with money piled high in wheelbarrows desperately trying to convert it into real goods before it lost even more value.
That is not what is happening in Canada and other countries of the world using public money creation for COVID response. At the time, Germany had the challenge of repaying debt owed to other countries in foreign currency, that is not the case for Canada and other countries issuing debt in their own currency.
The main reason we do not need to fear inflation right now is that public money creation is backfilling demand or expenditure in the economy that has cratered due to the COVID measures. There’s no reason to believe that there is too much money chasing around too few goods.
In normal times, it is the private banks that do the vast majority of money creation through the expansion of credit by financing mortgages and other loans to their customers. Money supply growth is often 6-12% per year through this mechanism.
Obviously, the banks and bank economists don’t like the competition. Far better for them to have a monopoly on money creation. The point is that anyone who goes to great lengths to talk about debt concerns without mentioning the Bank of Canada’s operations is missing a big part of the action.
If anything, we could use more of this proactive approach to monetary policy all the time, rather than ceding money creation to the chartered banks. This could form a new cornerstone of monetary policy post-COVID in support of major investments that are not forthcoming from the private sector (transitioning off of fossil fuels, for example).
The only other concern one might have is currency devaluation if financial markets were concerned about the Canadian dollar losing value due to public money creation. But all major countries are engaged in similar operations.
Bottom line: there’s no reason for debt hysteria right now, nor should COVID-related deficits be used to argue the federal government should not step up to other pressing challenges facing the nation, like reducing carbon emissions, building affordable housing or fighting poverty.
This piece was originally published on Policynote.
Marc Lee is a Senior Economist at the CCPA’s BC Office. Follow him on Twitter at @MarcLeeCCPA.
