Trudeau’s Stimulus Push Runs Into Trouble With Economy Heating Up

Prime Minister Justin Trudeau is about to make a pitch for tens of billions of dollars in new spending after racking up one of the developed world’s largest deficits. There’s one problem: Canada’s economy doesn’t need it.

Not only are Canadians sitting on hundreds of billions in unspent cash -- partly because Trudeau’s virus relief programs were among the most generous anywhere -- but Joe Biden’s $1.9 trillion stimulus package is adding to a wave of unprecedented U.S. spending that’s spilling over the border, juicing growth in Canada and Mexico too.

As a result, the northern nation’s economy is healing faster than expected: 90% of the jobs lost when the pandemic hit have been recovered, and the labor market is coming off two months of huge gains. Confidence gauges have jumped to near records and economic growth this year is expected to be the fastest in five decades.

Trudeau’s Stimulus Push Runs Into Trouble With Economy Heating Up

The prime minister has signaled plans for as much as C$100 billion ($79.5 billion) in additional spending for priorities like childcare in his April 19 budget. But the economy’s upward turn has many -- including Canada’s most powerful banker -- questioning the wisdom of an expansionist fiscal policy.

“I would counsel that we don’t want to overdo this,” David McKay, chief executive of Royal Bank of Canada, said last week when asked about the budget. “Why not keep our powder dry and see how we recover, knowing that we’ve got this dry powder to interject quickly -- as we’ve shown we can do in the past year -- if things aren’t playing out the way we hoped.”

It’s not a new worry in a country with a decades-long political consensus that deficits should be small, temporary or non-existent. The Covid-19 pandemic shattered that ideal, with the federal government running a shortfall of 17% of gross domestic product in the fiscal year that ended March 31, according to parliamentary budget office projections -- a record shortfall in the postwar era.

Electoral Politics

Political considerations are key. Trudeau’s incumbent Liberals kept power but lost their parliamentary majority in 2019, forcing the government to rely on opposition parties to pass legislation. Polls put the prime minister’s party in the lead and he may want to use a big-spending budget as a launchpad for a new election, with an eye on regaining his majority.

Concerns about the deficit led Trudeau’s government, four months ago, to pledge that any new spending would be pegged to labor-market outcomes. Now that the jobs market looks robust, Trudeau and his finance minister, Chrystia Freeland, will likely try a different sales pitch -- one focused on long-term growth and social justice, rather than an economic emergency.

Trudeau has been making the case for deficits from his first day in office. Infrastructure is crumbling. Incomes for the many remain stagnant while growing for the rich few, and the gap has been widening during the pandemic, according to economists at Canadian Imperial Bank of Commerce. Now with interest rates so low, there’s an opportunity to use government borrowing power to enhance growth for years to come.

What Bloomberg Economics Says...

“Canada’s response to the pandemic outpaced peers. Even so, our analysis shows that even under less benign interest rate scenarios, the country would still enjoy relatively low debt interest burdens. Decades of fiscal belt-tightening provided the space to act.”

--Andrew Husby, economist

For the full BE primer on Canada, click here

That argument gets a sympathetic ear from some analysts. Jean-Francois Perrault, chief economist at Bank of Nova Scotia, believes the country could set aside its deficit aversion for a bit longer, as long as spending is focused on fixing long-term growth problems -- just like Biden is trying to supercharge the U.S. economy with spending on roads, mass transit, broadband and other projects.

Before the pandemic, Canada was in a low-growth state, hobbled by an aging labor force and sluggish productivity. That hasn’t improved under Trudeau.

“The Americans are basically saying they are going to push the envelope,” Perrault said in an interview. “If it’s a well-thought-out plan to raise living standards in the country, to raise potential output, in my mind it’s going to be a little bit difficult to be critical of that.”

Even an additional C$150 billion would make sense, Perrault said. (On a per per-capita basis, that would be the equivalent of about $1 trillion in the U.S.)

Trudeau’s Stimulus Push Runs Into Trouble With Economy Heating Up

After all, Canadian government debt remains lower than most other Group of Seven countries, even with the dramatic increase in the past year. That means public finances are less vulnerable to any spike in rates.

But there’s something disquieting to Canadians about the deteriorating fiscal picture in Ottawa. Before the pandemic, the federal government was the one part of the economy that wasn’t accumulating tons of debt.

The nation’s mortgage-hungry households and its companies have borrowed like mad, driving Canada’s total debt outside of the financial sector to about about 350% of GDP, well above average for advanced economies.

In a survey last month by Nanos Research for Bloomberg News, more than 80% of respondents said they care about the amount of red ink. “Canadians want stimulus and are OK with the deficit but care about the size,” pollster Nik Nanos said by email.

Trudeau’s Stimulus Push Runs Into Trouble With Economy Heating Up

Skeptics of larger deficits say Biden’s fiscal policy actually favors less spending in Canada, which will get a free ride off American stimulus. In Mexico, which is another big winner from U.S. pandemic spending, Andres Manuel Lopez Obrador has run one of the world’s most austere budgets through the Covid-19 crisis.

With an election expected in Canada, it’s going to be a tough balancing act.

Trudeau is hoping an ambitious agenda will cement his political legacy. Freeland, the first woman to be finance minister, will also want to leave her mark. At the same time, both will be wary of spooking voters -- reluctant to forfeit a rare polling advantage over the Conservative Party on fiscal management.

For economists, just as important as the size of the deficit is what it’s spent on.

“Is it near-term measures? Then I’d say, yeah it’d be too much,” Beata Caranci, chief economist at Toronto-Dominion Bank, said in an interview. “Is it on long-term structural changes? That would be positive.”

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