Ever woken up after a spending spree and hacked your credit card in half with the nearest pointy object?
It can be a wise thing to do. It’s what Canadians did in 1997 after more than 25 years of federal deficits. As Paul Martin has reminded us in hundreds of speeches since, our debt was more than $600 billion and interest payments were eating up more than one-third of tax revenues.
Remarkably, the interest payments had so crippled our federal institutions that even the rabid free marketeers in the United States were spending a greater percentage of their national income on government programs than we were.
Since then, balanced budgets have become as Canadian as the CBC or a Tim Hortons double-double. Suggesting a deficit can end the career of a politician from any party.
But now, because of the global credit crunch, the situation has changed. We probably need to rethink some of our national shibboleths (don’t worry, I mean balanced budgets not Tim Hortons).
It took us more than 10 years of debating deficits, starting with the tentative cuts of the Mulroney era to Paul Martin’s first surplus, to create a new consensus around responsible fiscal policy.
Unfortunately, the credit crunch is happening much faster.
It is also more dangerous.
Economists differentiate between “plain vanilla” recessions and recessions with the added bitterness of a banking crisis.
International Monetary Fund economists recently pointed out that recessions linked to banking crises can be two- to three-times deeper and last two- to four-times longer. That’s four- to 12-times as much misery.
In Canada, we are used to recessions that respond well to interest rate cuts and “automatic stabilizer” programs, like employment insurance that automatically increase in tough times.
This time, however, these tools may not work.
Interest rates are already at extremely low levels and they can’t go below zero. Employment insurance and welfare can help families in need, but can’t replace massive reductions in business investment and household spending by frightened decision-makers.
Even multi-billion dollar programs to recapitalize banks may not be enough. You can give bankers capital, but you can’t make them lend.
Furthermore, economic decisions are as much emotional as rational, as economist John Maynard Keynes pointed out when he referred to the “animal spirits” at work in markets.
A fall in economic confidence can become a self-reinforcing cycle. Households and businesses expecting a deep recession will cut investment and spending even further, fulfilling their own expectations.
There are several historical parallels. The first is President Herbert Hoover, whose fiscal orthodoxy is blamed for making the Depression much worse that it needed to be. The Japanese, in the mid-1990s, also ran tight budgets during a banking crisis that likely prolonged the their slump for years.
This means we have to think again about fiscal policy. Politicians in Ottawa have been saying the word “stimulus” lately, but few inspire confidence that they plan anything more than spraying money around like it was 1974 again.
We may need to run a deficit, but if we do, we need to do it intelligently. There are several principles to keep in mind.
Timing and scale. If a stimulus is worth doing, it is worth doing as soon as possible. That means significant action announced by February. In terms of scale, IMF economists have tossed around the figure of two per cent of gross domestic product, depending on the severity of the recession in a country. This would work out to around $30 billion for Canada.
Highest impact. We should choose ways to spend the money that stimulate the most economic activity. The Harper government’s GST reductions, while allowing large dollar amounts to be inserted in press releases, likely spurred limited additional consumer spending. Some governments have tried rebate cheques to taxpayers, but in severe recessions these can be less effective since many consumers treat them as one-time windfalls and use them to pay down debt.
The highest impact expenditures are probably transfers to less prosperous Canadians, who are more likely to spend them, and labour-intensive projects such as retrofitting homes with better insulation and heating technology. Broad-based corporate and personal income tax cuts can also be effective, especially if the latter are focused on lower income Canadians. Employment insurance premiums are effectively a regressive tax on jobs, so cutting them could make good sense too.
Fiscal responsibility. Suggesting a big deficit during the credit crunch is not the same as advocating permanent red ink. In the UK, Gordon Brown brought in the “golden rule,” which required that government deficits over the ups and downs of the business cycle be used only to “invest” in national assets.
President Bill Clinton was notorious for his flexible interpretation of the word “invest” but the principle is correct. We should adopt it, and run surpluses again in a few years.
Investing for the future. We should focus additional spending on programs that build for the future. Airports, schools, internet infrastructure, renewable energy projects as well as vocational training and K-12 and university education should be prioritized over corporate welfare.
Consider the Schwatka hydro project in Whitehorse. It has given us decades of clean, cheap power. We are much better off for that project than if Ottawa had used the money to keep a Studebaker factory operating for another 18 months.
Things may not be as bad as this economist predicts.
Maybe a big stimulus program will turn out to have been overkill. It is possible. But remember the question Alan Greenspan always used to ask when comparing policy options: what are the costs of being wrong?
If we enact a big stimulus and the recession turns out to be milder than expected, we will end up with some extra schools and internet networks and a few extra points on the national debt ratio.
If, however, we dither and the recession hits hard then we will face years of unneeded economic losses plus unnecessary hardship for millions of Canadian families.
It will take some bold political leadership to sell this story to deficit-shy Canadians.
Even Franklin Roosevelt, now famous for his big-spending “New Deal” during the Depression, campaigned in 1932 on a balanced budget platform.
President-elect Obama has shown less hesitation, promising even before taking office to invest billions and create 2.5 million jobs with investments in roads, schools and internet infrastructure.
So grab a double-double and turn on the CBC as parliamentarians jockey for position before Parliament reopens in January.
Watch which of our leaders actually lead on this issue and which “lead from behind” and play it safe with our now traditional “no deficits” mantra.
Keith Halliday is a Yukon economist and author of the Aurore of the Yukon series of historical children’s adventure novels. His most recent book Yukon River Ghost appeared in June.