The fiscal snapshot yesterday confirmed the severity of the
fiscal and economic impact of the pandemic on federal finances. GDP is
expected to shrink by 6.8 percent in 2020-21, government revenues are dropping
21 percent and spending is up 63 percent. Believe it or not, the numbers say something
about the elasticity of expenditures and revenues to a pandemic generated drop
in GDP. Based, on these percentages, it
seems that a 1 percent drop in real GDP growth is associated with about a 3
percent drop in federal revenues while the same 1 percent drop in real GDP
spurs a 9 percent increase in spending. Spending is definitely more elastic
than revenue.
Revenues are dropping from 341 billion dollars in 2019-20 to a projected 268.8 billion in 2020-21 while spending is going from 375.3 billion dollars to 612.1 billion dollars. As a result, the deficit is going from the original
projected 34.4 billion dollars to 343.3 billion dollars bringing the federal
debt to over one trillion dollars and the federal debt to GDP ratio to 49
percent. In nominal dollars, this is indeed the biggest deficit in
Canadian history but as a share of GDP it comes in at 15.9 percent putting it
behind the 20 percent plus ratios incurred during World War II. The accompanying figure gives a nice visual snapshot of the changes in the nominal values of some of the key variables.
The impact is serious but the economy and the federal
finances should be able to absorb this as a one-time shock. Moreover,
much of this new debt is being financed at very low long-term interest rates
and debt service charges will not change significantly. However, if this
happens twice then federal finances will head into a state where consequences
will be more severe. In the end, we are a small open economy and if everyone around the world starts to borrow at such rates, the increase in demand will eventually raise interest rates. The "small borrowers" will feel the pain first.
Canadians have been truly blessed by having their federal finances in relatively good shape heading into this crisis as it enabled their government to assist them. However, the economy needs to restart and pick up steam and much of this new spending wound down over the next 6 months to a year if we are to avoid more serious restraint as well as large tax increases one to two years down the road.
Canadians have been truly blessed by having their federal finances in relatively good shape heading into this crisis as it enabled their government to assist them. However, the economy needs to restart and pick up steam and much of this new spending wound down over the next 6 months to a year if we are to avoid more serious restraint as well as large tax increases one to two years down the road.