Federal Finances in Review

 

The last week has been a chaotic one in Ottawa given the resignation of the finance minister on the eve of the Federal Economic and Fiscal Statement (FES), the turmoil over the Prime Minister’s leadership and the ongoing verbal assaults of President-elect Trump on Canadian sovereignty.  Nonetheless, lost in all of this is that after a considerable delay, there has finally been an update to Canada’s Fiscal Reference Tables (FRT) and Figures 1-4 here provide an overview of both the past (1966-67 to 2023-24) as laid out in the FRT and the future (2024-25 to 2028-29) such as it is laid out in the FES. 

Figure 1 provides a nice snapshot of the federal fiscal footprint – the federal spending to GDP ratio. Over the period of this chart, the federal footprint reached a  maximum of 25.6 percent in 2020-21 during the pandemic. This was of a course an outlier year and if one takes this out, one nevertheless notices that from a low of 13.9 percent in 2013-14, the federal fiscal footprint has gradually drifted upwards notwithstanding the pandemic and in 2022-24 stood at 17 percent.  While not at the level of the 1980s when it exceeded 20 percent, it remains that the federal fiscal footprint both in 2023-24 and going forward to 2028-29 is the largest it has been since the late 1990s and marks a calculated expansion of federal public sector size relative to GDP.

 

 Part of this rising expenditure has been financed via borrowing and in 2023-24 the deficit stood at nearly $62 billion.  From 2023-24 to 2028-29, Canada is forecast to accumulate another $242 billion dollars in deficits bringing the national net debt to $1.549 trillion by 2028-29. Figure 2 plots the deficit to GDP ratio, and it stands at nearly 2 percent for 2023-24 and is forecast to drop to 0.7 percent by 2028-29 – assuming of course that given the deficits projected, nominal GDP growth proceeds at 4 percent annually.  Given the slowdown in the economy that appears to be underway and the likely imposition of US tariffs in 2025, this would appear to be an exceptionally rosy GDP growth forecast.

 

 Figure 3 plots the net debt to GDP ratio, and it began to take a definite upward path starting in 2019-20 when it went to 37 percent from 33 percent the year previous.  It peaked at just over 44 percent in 2022-23 and is only going to come down slowly to about 42 percent by 2028-29.  Now, while up by recent standards, it is nowhere near where it was during the federal fiscal crisis of the 1990s.  Yet, the debt is mounting, and interest rates are higher than they were during the debt and spending spiral of the pandemic and so debt service costs have gone up.

 

 In 2019-20, debt service costs were $24.4 billion representing about 7 percent of federal revenues that year.  For 2024-25 they are anticipated to be more than double at $53.7 billion or 10.8 percent of federal revenues.   By 2028-29, it is projected that annual debt service costs will reach $66.3 billion or 11.3 percent of federal revenues.  As Figure 4 illustrates, we are again nowhere near the numbers of the federal fiscal crisis when well over 30 percent of federal revenues went to service the debt. At the same time, we appear to have settled at a plateau over 10 percent for the foreseeable future and that is money better spent on programs.

 

 In her resignation letter, the outgoing finance minister appeared to have a fiscal epiphany as she noted the need to keep our fiscal powder dry to face the economic challenges coming down the pipeline.  The trends of the last few years suggest that there has been a certain dampness to federal fiscal powder for the last few years that is expected to persist into the future.  While there is still fiscal room to manoeuvre, a large recessionary shock will quickly erode that room given the gradual enrichment of long-term  federal spending via assorted initiatives over the last decade as illustrated by the federal expenditure to GDP ratio. This suggests that dealing with a major recession will be more challenging that it would have been a decade ago.

 

 

 This post originally appeared on the Fraser Institute Blog, March 25th, 2024.

Ontario government’s fiscal history drenched in red ink

— March 25, 2024

The Ford government will table its next budget on Tuesday. But a longer-term perspective on the evolution of Ontario’s government finances provides some important context for today. Since Confederation, Ontario has seen a massive expansion of its revenues, expenditures and debt. And its fiscal performance in terms of balancing its finances has oscillated over the years. Using data from the Finances of the Nation database, assorted Ontario budgets, and the Fiscal Reference Tables, a picture of change and variable fiscal responsibility emerges.

With revenues of $2.3 million and expenditures of $1.2 million in 1868, Ontario had a substantial surplus and no debt. Indeed, substantial surpluses marked much of the pre-Second World War era. By 2023, the Ontario government had spending of $199 billion and revenues of $193 billion for a deficit of nearly $6 billion and a net debt of $400 billion. Ontario government spending on a real per-capita basis was relatively modest from 1867 to 1913 (despite province-building activities such as roads and railroads) and was financed primarily by federal government grants and natural resource revenues from forestry and mining. The period after 1914 saw an expansion of both government spending and revenues that was quite dramatic compared to the prior period, but which paled in comparison with the post-1957 expansion into health, education and social services.

With respect to revenue composition, Ontario gradually shifted from a reliance on natural resource rents and government grants to own-source revenues from income, consumption and other assorted taxes. When compared to the federal government—the only other Canadian government larger than Ontario in terms of total revenues or expenditure—in real per-capita terms Ontario spent less than the federal government until the early 1990s surpassing the Ottawa in 1993 for the first time. By 2020, real per-capita Ontario government spending was actually more than federal real per-capita spending, though the pandemic years saw a reversal.

What’s truly remarkable about Ontario’s finances is its growing reliance on deficit financing since the 1970s. Over the entire 1867 to 2023 period, Ontario ran an operating deficit in 70 out of 157 years or approximately 45 per cent of the time. However, in the first 100 years from Confederation (1867 to 1967) Ontario only ran 22 deficits—that’s 22 per cent of the time. In the fiscal years from 1968 to 2023, Ontario ran 48 deficits in 55 years—or deficits 87 per cent of the time. Deficits have gone from being a temporary departure for exceptional times to a near permanent device.

The accompanying charts plot Ontario’s deficits, its deficit-to-GDP ratio, its net debt and its net debt-to-GDP ratio from 1960 to the present. The first chart illustrates that Ontario maintained its largely balanced budget approach to its finances for most of the 1960s but incurred deficits in the 1970s.

Its three largest deficits were in 2010 ($19.3 billion), 2011 ($17.3 billion) and 2021 ($16.4 billion). As a share of GDP, the second chart illustrates that Ontario’s three largest deficits were in 1992 (3.7 per cent), 1993 (4.1 per cent) and 1994 (3.5 per cent). Ontario’s pandemic deficit peak in 2021 came in at 1.7 per cent placing it lower than some of the deficits of the 1970s and early 1980s.

Deficits plus interest eventually result in accumulated debt and Ontario like other provinces has added to that by borrowing for capital spending on top of its operating deficit. As the final chart shows, in 1960 Ontario had a net debt of $994 million and net debt-to-GDP ratio of 6 per cent. Today, net debt tops $400 billion and the net debt-to-GDP ratio is about 36 per cent. The profiles for net debt and net debt-to-GDP suggest Ontario’s net debt has grown in three phases.

The accumulation of net debt takes off in the mid 1970s, then accelerates in the 1990s and accelerates yet again after 2008. These periods of acceleration have all coincided with periods of economic slowdown or recession in the province—the low growth stagflation era of the 1970s, the recession of the early 1990s and recession/financial crisis era of 2007 to 2009. In each of these periods of distress, deficits mounted, yet even when the economy and revenues began to recover, spending growth and deficits continued. In essence, the Ontario government ran deficits during bad times and better times, giving a fiscal dimension to the provincial motto “Loyal She Remains.”

As Ontario moves forward from the pandemic era, it remains to be seen if the government will rein in perpetual deficit financing and halt debt accumulation, or if the government will embark on yet another cycle of mounting debt. In many respects, the government has continued to spend at a rate well above its economic ability and performance. Key to the issue is Ontario’s productivity lag, which has resulted in slow growth relative to the rest of the country. If the Ford government continues to spend as if Ontario was still experiencing the high growth rates of an earlier era, that’s not a sound recipe for fiscal responsibility.

Interest and Debt

 

Wednesday's Bank of Canada rate increase reminds us once again that the era of cheap money is over not just for consumers and business but also governments. One of the notable features of the pandemic response in Canada was the enormous amount of federal fiscal stimulus injected into the economy.  Federal spending rose from $363 billion in fiscal 2019-20 to reach $639 billion in 2020-21 – an increase of 73 percent.  It then began to subside going down to $480 billion as reported in Budget 2023 but is set to resume an upward trend and reach $556 billion by 2027-28.  As of the 2022-23 fiscal year, federal spending is 37 percent higher than going into the pandemic meaning an average annual increase in spending of about 12 percent.  This has been funded by deficits which in turn have increased the federal net debt dramatically going from $813 billion in 2019-20 to $1.3 trillion by 2022-23 and is expected to reach just over $1.4 trillion by 2027-28.

 

The long-term implications of this spending and debt surge are of course debt service costs. As a result of recent interest rate increases, they are about to become in nominal terms the largest, they have ever been.  Using data from the federal Fiscal Reference Tables and Budget 2023, Figure 1 plots both the total annual amount of federal debt charges paid as well as the annual percent increase for the period 2000 to 2022 and then as forecast until 2028.  What is evident at a glance is that until 2021, annual debt charges had been on a downward trend falling from nearly $44 billion in 2011 to $20.4 billion in 2021.  Since then, they have soared growing 20 percent in 2022 and forecast at 41 percent and 27 percent growth in 2023 and 2024 respectively before subsiding.  Indeed, by 2028, annual debt service costs are anticipated under the current forecast to reach over $50 billion which surpasses even the peaks reached in the 1990s. 

 

 

 

Now of course, as a share of total federal government spending, these debt charges may seem less alarming as at less than ten percent of total expenditure, they are modest relative to peaks of nearly 30 percent or more in the 1990s and 1930s. However, it should be noted that the share of total federal government spending going to debt service more than doubled between 2021 and 2023 rising from 3.2 to 7.2 percent and is expected to keep rising to just over 9 percent by 2028.  Nothing to worry about you might think?  However, it all depends on what happens to interest rates.  The fact remains that not surprisingly there is a strong correlation between the growth rate of federal debt charges and the effective interest rate on the net federal debt.

 

 

 

Figure 2 plots the annual percent change in federal debt charges against the effective interest rate on the net debt since 1867 (calculated as debt charges divided by net debt) using data from A Federal Fiscal History, the federal Fiscal Reference Tables and Budget 2023.  With a linear trend fitted, there is a definite positive correlation that has a bigger impact than you might think.  On average, a one percentage point increase in the rate of interest is associated with a nearly two percent increase in debt charges.  Given such sensitivity, it is not a surprise that debt charges have doubled since 2021.  And the current situation is anything but average given the enormous stock of nominal debt meaning that even with the staggering of long-term government bond debt issue, small interest rate increases can have large increases in government debt interest costs.  Moreover, with the anemic real GDP growth forecasts and an increase in interest rates, the long-term sustainability of the federal fiscal position becomes more of an issue.  We are in for interesting times.

Ontario's Net Debt: A Long Term Overview

 

With all the focus on the US debt ceiling political debate, it is sometimes easy to lose focus on our own debt situation at both the federal and provincial levels.  Taking a long-term view on Ontario’s net public debt of course requires data and as part of my ongoing efforts on putting together Ontario’s fiscal history, I have been able to get Ontario’s provincial government net public debt back to 1914.  The data comes from two sources.  First, there are the more recent numbers going from 1966 to the present which are obtainable from Finances of the Nation and the Ontario Financing Authority.  As for the pre-1966 numbers, there are a number of provincial budgets from the early and mid-1960s which among other things contain a lot of historical data on revenues, expenditures, deficits and debt.

Ontario from 1867 and into the early 20^th century generally ran surpluses largely due to the bountiful natural resource revenues from forestry and mining rents and royalties.  The acquisition of large amounts of capital debt appear to coincide with northern Ontario infrastructure development of the early 20^th century – in particular the advent of the Temiskaming and Northern Ontario railroad circa 1902. Further expansions of debt occur during and after World War I with the advent of the motor care and provincial highways as well as the expansion of the hydroelectric grid.  And of course, there is the Great Depression which played havoc with public finances.   Ontario’s net debt numbers begin in 1914 (See figure 1) at just over 6 million dollars and by1945 had reached 480 million dollars.  Between 1945 and 1960, Ontario’s net debt grows to 994 million and in 1961 Ontario’s net debt tops one billion dollars.  By 1980, Ontario’s net debt had reached nearly 11 billion dollars and grew to just over 35 billion by 1990.  It is the period since 1990 that sees an even more rapid expansion of nominal net debt growing to 134 billion dollars by 2000, 194 billion dollars in 2010 and then about 380 billion dollars by 2022.  Over 90 percent of Ontario’s net public debt has been acquired since 1990.

 

 

 

 

Of course, nominal numbers alone are not sufficient as it is the size of the debt relative to the economy - the net debt to GDP ratio – that matters more.  Figure 2 illustrates this quite nicely.  The Great Depression era sees a first peak of the Ontario net debt to GDP ratio in the 15 to 20 percent range.  It then falls and levels off at about 5 percent going into the 1970s.  After that it begins an overall rise with particularly steep jumps during periods of recession – in particular, the early 1990s, and the era of the Great Recession/Financial Crisis 2007 to 2010.  As a result of fairly generous federal transfer support, the pandemic did not see as large a spike in Ontario’s net debt to GDP ratio as these other two periods.  

 

 

 

In the end, while the size of the provincial debt in nominal terms seems to shake a lot of people, it is debt relative to the size of the economy that should generate greater concern.  The Great Depression Era aside, Ontario generally had a net debt to GDP ratio at about five percent up
until the 1970s.  The period since the 1970s represents a period where the ratio has generally trended upwards.  If one defines fiscal sustainability as a stable or declining net debt to GDP ratio, then the period before 1970 can be seen as one where Ontario’s revenue and expenditure structure was generally fiscally sustainable.  One cannot say the same with respect to the period since 1970.  And yet, it would appear that despite occasional fits of rhetoric, Ontario has not been stirred to action when it comes to its net debt.

 

 

Revisiting the Federal Finances

 

In the wake of the Federal 2023 spring budget, it is useful to take a look at the historical picture to see how the present and the immediate projected future fits into the long-term pattern of federal spending.  The key defining issue of recent public finance and government spending was of course the pandemic and the enormous amount of federal fiscal stimulus that was injected into Canada’s economy.  Federal spending rose from $363 billion in fiscal 2019-20 to reach $639 billion in 2020-21 – an increase of 73 percent.  It then declined reaching $480 billion as reported in Budget 2023 but is set to resume an upward trend and is expected to reach $556 billion by 2027-28.  As of the 2022-23 fiscal year, federal spending is 37 percent higher than going into the pandemic meaning an average annual increase in spending of about 12 percent.  This has been funded by deficits which in turn have increased the federal net debt dramatically going from $813 billion in 2019-20 to $1.3 trillion by 2022-23 and expected to reach just over $1.4 trillion by 2027-28.

 

A key feature of the pandemic is what appears to be a dramatic reversal of the decline in federal program spending as a share of Canada’s GDP – the so-called “federal fiscal footprint”.  Figure 1 uses data I compiled for my 2017 federal fiscal history with updates from the federal Fiscal Reference Tables and Budget 2023 to look at the program expenditure to GDP ratio for Canada from 1867 to 2022 and then projected forward to 2028. Fitting a simple linear trend shows that over time, there has been an expansion of federal program expenditures relative to GDP rising from about 5 percent in the 1870s to about 15 percent by the 1980s and with the COVID expenditure bump approaching 17 percent. 

 

 

 

Of course, there have been ebbs and flows around this linear trend with notable spikes during WWI and WWII.  It is noteworthy that the COVID spending spike represents the second highest federal program expenditure to GDP share with World War II as the highest.  After the spike and drop of the war era, the post WWII period saw a gradual rise in the federal fiscal footprint that saw it rise from about 10 percent in 1948 to peak at nearly 19 percent in 1982 and then decline, reaching 11 percent by 2000.  Since 2000, it has risen with a spike in 2021 at the height of the pandemic that brought the program expenditure share of GDP to 23 percent.  It has since declined to about 15 percent.  However, going into the pandemic it was just under 14 percent, up 1 percentage point since 2014 and the forecast of 15 percent means the federal footprint has returned to the size it had in the late 1970s to mid 1980s. 

 

Of course, we all know what happened after that.  There was a rise in the federal debt as a result of accumulated deficits and high interest rates that at first squeezed out program spending – note the decline into the 1990s even before the federal fiscal crisis – and then of course the transfer cuts and program expenditure reductions of the federal fiscal crisis. This of course makes the role of debt charges and interest rates of particular interest and Figure 2 plots two series: federal government debt charges as a share of total federal government expenditures and the effective interest rate on the federal net debt (defined as debt charges divided by net debt).  

 

 

 

The period from 1870 to WWI saw a decline in interest rates and not surprisingly a decline in the debt charge share of federal spending.  What surprises most people is that as a result of all the provincial debt the federal government took on at the dawn of Confederation, about 30 cents of every federal dollar of expenditure was going to service the debt in 1867.  Spending on nation building infrastructure such as railways saw debt levels and debt charges accumulate in the 1870s and 1880s but then came the great boom of prairie settlement after 1896 .  World War I saw an accumulation of debt and a rise in interest rates and with the budgetary and economic shocks of the Great Depression, debt charges as a share of total federal spending remained at over 25 percent.  Indeed, there is probably an interesting economic history thesis in explaining why there was a federal fiscal crisis in the 1990s but not the 1920s. 

 

The post WWII era saw a rise in interest rates that surpassed even the rise of the pre-WWI era and as significant budget deficits and debt began to accumulate after the mid-1970s, debt charges as a share of total spending began to rise.  However, with the positive budgetary balances of the post fiscal crisis era as well as the decline in interest rates, both interest rates and federal debt charges as a share of total spending hit historic lows.  In 2021, federal debt charges as a share of total federal spending was just below 5 percent and the effect interest rate on the net debt was about 1.8 percent.  Those numbers will be ones for the economic history books in the years to come as the debt service share of federal spending approaches 10 percent and the effective interest rate is just under 4 percent.  At least, that is what is currently forecast.

Ontario’s Spring 2021 Budget: The Future Looks Bleak for Health Care

 

Well, the Ontario 2021 budget came out yesterday and it is rightly preoccupied with the COVID-19 pandemic.  COVID-19 funding and support will continue to flow for the next couple of years and along with the $20.1 billion of support in 2020-21, there will be an additional $6.7 billion and $2.8 billion in the subsequent two years before the government anticipates a return to  some type of normalcy. 

 

For 2020-21, the deficit is estimated at $38.5 billion and for the 2021-22 fiscal year it is expected to be $33.1 billion and then $27.7 billion the year after.   However, the government has actually proposed a fiscal plan for getting to a balanced budget –but it is very long-term.  Deficits are projected to continue falling until 2029-30 when there will finally be a $900 million-dollar surplus – assuming the projections for economic growth and spending take shape and indeed, that the world should last so long.

 

Figure 1 presents the numbers for total revenues, total expenditures and the deficit out to 2029-30 but also puts them into historical perspective.  The numbers are from the Fiscal Reference Tables for the 1990 to 2019 period with GDP numbers from Statistics Canada and the Ontario 2021 Budget for the years after up until 2029. If these projections come to pass, Ontario will have run since 2008-09 a total of 21 budget deficits before reaching “balance” in 2029-30 resulting in accumulated deficits of $284.9 billion.  By 2029, Ontario will be taking in $210.1 billion in revenues – up 35 percent from 2019-20 – and then spending $209.1 billion- up 27% from the same reference point. The net debt that will rise from $397.2 billion in 2020-21 to reach an astounding $585.3 billion by 2029-30 and a net debt to GDP ratio that will remain just short of 50 percent for an entire decade.  Moreover, as the stock of debt rises, so does debt service and its rises from $12.5 billion in 2021-21 to $20.6 billion in 2029-30 – an increase of 65 percent.

 

 

 

It indeed will be the roaring twenties when it comes to the growth of net debt and debt service costs in Ontario.  Ontario’s fastest growing expenditure category from 2021 to 2920 will be debt service costs.  The average annual growth rate for nominal health spending is expected to be 2.6 percent.  Education will grow at an annual average of 1.1 percent, post-secondary education at 1.2 percent, children and social justice comes in at 0.6 percent annually (so much for children as the future) and interest on the debt at 5.1 percent. 

 

The results for health care spending are particularly at odds with the Ford government’s commitment to increasing hospital capacity and long-term care.  While base health spending – that is not including the short-term COVID-19 bump -  is projected to grow at 2.6 percent a year, it means that given population growth of about 1 percent annually and inflation of 2 percent, real per capita spending on health will at best stay flat and even decline somewhat.  

 

This will come after nearly a decade of relatively flat real per capita provincial government health spending in Ontario and it seems to conflict with government claims it is going to boost health and long-term care. We do seem to be heading for a rather dire fiscal future in which the budget is not going to be balanced, the public finances are not sustainable and spending on important things like health will actually decline in real per capita terms.  It is indeed a rather bleak looking future for health care in Ontario despite all the government spin.

Governments betting on low interest rates may experience rude awakening

 

Governments in Canada and around the world have run large budget deficits and greatly added to their debt loads due to their pandemic response and the accompanying economic downturn. Moreover, they are poised to add even more debt in coming year to provide further stimulus to kickstart moribund economies.

Indeed, the new Biden administration plans a $1.9 trillion economic package on top of the $2 trillion relief bill in March and additional $900 billion in December. As for Canada, the Trudeau government is poised to spend $100 billion in stimulus on top of a record deficit approaching $400 billion.

Clearly, governments worldwide went into the pandemic with large debt loads and will emerge with even bigger ones. However, the large deficits are justified on the grounds that we need to kickstart the economy and it’s a good time to do so because interest rates are at historic lows, making debt-service costs extremely manageable. In many respects, there’s a great gamble underway. We’re rolling the fiscal dice, anticipating that interest rates will not rise anytime soon and will remain below the growth rate of the economy, thereby ensuring sustainable debt burdens.

On the surface, the grounds for such optimism are supported by economic history. The long-term trend for interest rates over the last few centuries has gradually been downward as economic development and capital-labour ratios have grown, raising the return to labour (wages) and reducing the return to capital (interest rates). Indeed, this process has been documented by Jorda, Singh and Taylor with medieval interest rates of about 10 per cent falling to four per cent by the 19th century and now approaching one per cent.

In the wake of pandemics such as the Black Death and the Spanish Flu, the long-term downward trend has been amplified by further short-term depression of interest rates. Essentially, pandemics increase mortality, making labour scarcer, and also increase savings rates as people hunker down and spend less. Both effects make capital more abundant relative to labour and lower the return to capital. If the COVID pandemic is true to form, one might expect the next decade to also feature ultra-low interest rates, justifying the current debt acquisition gamble.

Yet, there are reasons why this time may be different.

First, the current low inflation environment may soon end. The large budget deficits worldwide, competing for funds and resources, may eventually put upward pressure on prices and interest rates.

Moreover, the rise in trade barriers may lead to rising costs as global supply chains become less smooth, further adding to inflationary pressure. Indeed, some think Canada may be among the first countries to start raising interest rates due to stronger commodity prices as economies recover despite Bank of Canada positions to the contrary.

Second, in historical pandemics, the mortality impact has been on much younger populations and as a result the labour force impact has been more severe. Unlike the Spanish Flu, for example, COVID’s mortality impact has been disproportionately felt by seniors as opposed to prime working-age younger demographics more engaged with the labour force. Indeed, the labour force disruption and reductions of COVID are mainly the result of measures taken to reduce the spread of the virus. Once the virus is contained, these reductions should abate.

Taken together, governments around the world should not bet big by taking continued low interest rates for granted as they add to their debt pile. One year ago, nobody was thinking about COVID-19 and its economic effects. Today, few seem to be thinking about potential interest rate increases. Governments may feel lucky as they boost deficit-spending in a game of fiscal roulette. But the real question we must ask ourselves is: do I feel lucky?

 

This appeared in the Fraser Institute Blog on January 20th, 2021.

Deficits, Inflation and Interest Rates: A Very Simple Analysis

 

The immediate impact of COVID-19 on Canada’s economy - like many others - has been a drop in GDP and a massive ramping up of government deficits given the collapse in revenues and in increase in emergency spending and benefits.  At the federal level, the deficit for 2020 is anticipated to be closer to $400 billion. In the wake of Wednesday’s Throne Speech there should be a fiscal update or budget that will provide further fiscal details.  In the meantime, it is worth thinking a bit about what the ultimate impact of such large deficits will be not just in Canada but on the world economy.

 

The traditional aggregate demand(AD)-aggregate supply(AS) framework for looking at fiscal and monetary policy suggests that large deficits will shift AD to the right and raise price (P) and output (Y).  The increase in prices then triggers inflationary expectations which shifts the aggregate supply curve upwards starting a wage-price spiral.  Bringing inflation under control ultimately then requires tighter monetary policy that raises interest rates and brings down aggregate demand and inflationary expectations. It all seems simple enough except since 2008-09, the massive deficits incurred around the world do not seem to have done any of this.  Indeed, inflation is low and interest rates have gone lower.  The world is awash in cheap money.  And, Modern Monetary Theory (MMT) has been gaining ground with arguments that we can stimulate demand practically forever by having sovereign governments with their own currency increasing the money supply.

 

I think if we had to draw a picture of the global economy under the current situation, it looks something like this (Figure 1):

 

 

 

If we think of the world economy as a giant AD and a giant AS curve, the AD curve has a traditional downward slope, but the AS curve is flat rather than upward sloping or vertical.  That is, world aggregate supply as a result of integrated international supply chains, trade, increasing capital mobility, technology and digitization – essentially the results of globalization since the 1990s – has become perfectly elastic.  As a result, even with deficits and cheap money shifting that aggregate demand curve repeatedly to the right, there has been no inflationary pressure.  Supply has expanded to accommodate demand and hence inflation has stayed low and there has been no upward pressure on interest rates.

 

This means that in a sense we are going to be able to both have our cake and eat it for some time.  Inflation will probably not rear up its head anytime soon and interest rates are going to stay low and probably below the rate of economic growth meaning that governments will not face immense debt service or debt burdens from their massively expanding debt.  However, I think eventually, the global economy is going to more likely start to resemble Figure 2 down below:

 

 

 

While one can argue that the economy has always been global, modern economic history has been marked by two distinct periods of globalization: 1870 to 1914 and 1990 to 2016.  The first great globalization coincided with the hegemony of the Pax Britannica, the  industrial age and the liberalization of the world economy which came to a crashing halt with World War I and which then took decades to resume.  After the shocks and trauma of trade restrictions, world wars, political extremism and the Depression, the post-World War II era saw slow steps to more trade and the fall of the Berlin Wall marks the start of the second age of globalization and trade liberalization which moved together with the internet and rapid technological change in communications, and China’s rapid industrialization and development. Much of this growth of trade occurred under the hegemony of the Pax Americana and included shifting of production to lower labour cost environments.  This age was dealt a blow by the 2008-09 recession and came to an end with the rise of populism and trade restrictions which officially begin with the election of Donald Trump in 2016 and the American retreat from a more global role.

 

The second great globalization essentially flattened the aggregate supply curve which is why inflationary pressure has been muted.  Because of technological change, improved transport and communications, the shifting of production to the cheapest spot with integrated supply chains, and freer trade – the aggregate supply curve became perfectly elastic and able to accommodate rising AD at an almost infinite pace.  However, we are now in a volatile  transition period that has been aggravated by the pandemic. Since 2016, there have been more trade disputes, concern and push back against China’s seeming unwillingness to play by the rules of a more liberal-democratic world economic order, and trade disruption by populist politicians.  The end result of this will be an AS curve marked by higher costs of production with output expansion – in other words, more of an upward sloping curve. 

 

The result of expanding demand with an upward sloping AS curve will be rising prices and hence the return of inflation.  Combine this upward pressure on prices with eventual competition for borrowers to take on more and more government debt and there will be a rise in interest rates.  The events of the last five years have ensured that interest rates will rise – it is not a question of if but when.

Thunder Bay's Big Municipal Debt Problem

In lead up to a decision to approve a new municipal  $33 million Indoor Turf Facility that will add $15 million to the City of Thunder Bay’s debt and take the remainder from the reserves, comes the Treasurers Report that will be presented at this evening’s Council Meeting.  There is a lot there for the year ended December 31^st, 2019 but one of the things that stands out is the City’s debt position which faces “challenges” that as the report notes include increasing costs of programs and services, a debt to reserve ratio that is higher than the industry average (i.e., other municipalities), reduced funding from senior levels of government and low assessment growth among other things.

The two accompanying figures drawn from numbers taken from the Treasurer’s Report highlight quite dramatically what this looks like.  Thunder Bay’s per capita municipal debt (Figure 1) rose from $1,618 in 2015 to $1,839 in 2018 – an increase of 14 percent.  Over the same period, its provincial municipal counterparts on average went from $699 per capita to $758 – an increase of 8 percent.  By 2018, the per capita municipal debt in Thunder Bay was essentially more than twice that of the average in Ontario. Of course, if one has reserves, then the potential impact of the problem is mitigated.  However, as Figure 2 shows, while the average in Ontario is essentially one dollar in reserves for every dollar in outstanding debt, in Thunder Bay the ratio is nearly double at 1.7 (i.e., $1.70 in debt per dollar of reserves).   

 

 

Compared to the average in Ontario, we are more indebted and have a weaker reserve position.  We are going into the 2021 budget season with what is now a “trimmed” $7 million dollar COVID-19 induced budgetary shortfall which also has to be dealt with to which one of the proposed solutions among other things is a “special one-time tax levy.”  In this environment City council is considering adding another $15 million dollars in borrowing which will add upwards of $130 dollars per capita to Thunder Bay’s total outstanding municipal debt. 

At this evening’s meeting, if councilors are planning another marathon 5 hour session to things like loitering bylaws and minor zoning amendments, perhaps they might consider devoting a mere hour or so of their time to understanding the financial implications of Thunder Bay’s mounting debt given its historic inability to keep it within “industry averages”.

Some Recent Posts, Activities and Other Musings

Along with Northern Economist, I also contribute to two other blogs - the Fraser Institute and Worthwhile Canadian Initiative.  I try to post material related in some way to Northern Ontario on this blog - albeit with a fair number of exceptions.  My posts on the other two blogs tend to be almost exclusively on either provincial, national or international economic issues and often with a strong economic history bent.

I just did a post on Worthwhile Canadian Initiative comparing the most recent employment numbers to what transpired in the early 1980s.  The inspiration for this was a number of media reports that gushed positively to no end about how well employment was performing and that there was plenty of steam left in Canada's economy.  Indeed, a number of stories noted that Canada's January-February employment growth in 2019 was the best since the same two months on 1981.  Of course, all of these stories neglected to add what happened after February 1981 which was one of the most severe recessions in the postwar period that saw unemployment rates peak at nearly 13 percent.  For this post, click here.

And then there are my last two posts on the Fraser Institute blog.  As part of the lead up to the March 19th Federal Budget, I take a look at federal government finances and note that large deficits are on track until 2022-23.  A key point is that there has not been a revenue slowdown.  While these deficits might be understandable during a recession or as part of a strategic investment mandate, it is not really the case here.  It is just more spending.  For this post, click here.

Finally, a post on the evolution of the United States federal debt looks at the the contribution to the debt to GDP ratio ranked by president all the way back to George Washington who incidentally was pretty good at fiscal management given the hand he was dealt in the wake of the American Revolution.  Overall, wartime presidents have seen the largest increases in their debt to GDP ratios with Franklin Roosevelt and Woodrow Wilson topping the ranking.  For this post, click here.

Overall, it has been a pretty busy time between blogging, the occasional media interview (did The Current in December with an interview after Stanley Fischer) working on research papers in health and historic wealth inequality, public presentations - did Port Arthur Rotary in November and on the books for Fort William Rotary in April - and other assorted research projects.  Of course there is never enough time to do everything and my historical projects on Lakehead Port Statistics pre-1950 and constructing a fiscal series for Ontario pre-1960 are going to take a lot longer than anticipated...

In other news, I am off on some travels this month.  Have a trip to Regina coming to visit their Economic Department and I will be heading off  to Sudbury and Laurentian University next week for a couple of presentations during their Research Week. My first presentation is a paper co-authored with Rob Petrunia (Lakehead) as follows:

Monday March 18th: 1:00 – 2:35 pm Economic Inequality and Crime Rates in Canada (Governors’ Lounge, 11th floor, R.D. Parker Building)The Department of Economics will present a talk by Dr. Livio Di Matteo (professor of Economics at Lakehead University) on a critical issue in an age of globalization and technological change: the rising trend in income and wealth inequality and its adverse social effects.

My second presentation is titled "Arrested Development: Northern Ontario's Economy in the Past, Present and Future and is part of the following session:

Tuesday March 19th: 10:00 – 11:30 am The Economy of Northern Ontario: Structural Changes and Implications for the Labour Market( Governors’ Lounge, 11th floor, R.D. Parker Building)The Department of Economics will present a seminar on the changing economic landscape and the effects of long-term structural changes on the labour market of Northern Ontario

The latter talk with be a pretty expansive overview of the history of Northern Ontario's economy in terms of its development, the host of government initiatives and plans over the decades, what has worked or not worked, and thoughts about the future.

If you are in Sudbury for Research Week, feel free to attend!

Ontario 2018 Economic Outlook and Fiscal Review: Commentary

The Ontario government delivered its Fall 2018 Economic Statement and the end result was not as dire as anticipated.  From a revised deficit of $15 billion dollars just weeks ago, the Ford government has now brought the deficit down to $14.5 billion – not the fiscal Armageddon many would have expected.  Indeed, some might argue that the fiscal statement was positively underwhelming given that there was not as significant a dent in the deficit as the rhetoric suggested, there was no timetable for balancing the budget, nothing about how to deal with a large net debt and the fact that the net debt is now $347 – up from an amount that was itself revised upwards to $338 billion from $323 billion only a few weeks ago.

Part of what is happening here is that the provincial government is facing a much larger fiscal challenge than it probably even itself realized.  The Ford government has promised to tackle the deficit and restore Ontario’s public finances.  It also wants to enact more tax relief (for example the LIFT credit for lower income workers) and wants to spend money on the promises it made – including infrastructure such as long term care beds.  At the same time, Ontario’s economy is expected to slow – eroding revenue growth – while interest rates are creeping upwards adding to debt service costs.

So, moving from its financial commission review 11 weeks ago, revenues are now projected to be $2.7 billion dollars lower going from $150.9 to $148.2 billion.  This is the result of the cancellation of cap and trade – which for 2018-19 is a $1.5 billion revenue hit – as well as a projected slowdown in land transfer tax and corporate income tax revenue.  This is accompanied by a decline in spending by $3.1 billion as expenditures go from $165.8 to $162.8 billion with much of this involving cancellation of previous government initiatives.  As a result of spending dropping just a bit more than revenue, the deficit is reduced $500 million from $15 to $14.5 billion.

A glance at spending by ministry showed that most ministry functions are still up from 2017-18, including health and education.  Ministries that are seeing drops include the Attorney General, Economic Development, Government and Consumer Services, Indigenous Affairs, Municipal Affairs and Housing and Tourism.  There does not appear to have been a major hit to any of the major transfer partners.  Infrastructure spending also is still on track and may be a factor in the increase in the estimate of the net debt to $347 billion. 

So, the long and short of it is that this is really a place holder fiscal statement.  There is really no significant dent in the deficit, no time table for balancing the budget and the net debt is higher than what was projected just 11 weeks ago.  If the Ford Government is sincere about reducing the deficit, it probably needs more time to develop and implement a strategy that "will require difficult decisions" and will tackle it in the spring 2019 budget.  Until then, we wait.

Wealth and Debt Accumulation in Early Financial Markets Stockholm Conference

I had the privilege of attending along with nearly 50 other participants  the "Wealth and Debt Accumulation in Early Financial Markets" conference that was held at the Stockholm School of Economics September 13-14.  The conference was organized by Elise Dermineur (Umea University/Stockholm School of Economics) and Håkan Lindgren (Stockholm School of Economics) who are both affiliated with the EHFF Institute for Economics and Business History Research at the Stockholm School. The conference united researchers working with a variety of historic sources of data on credit, wealth and debt but with very strong representation from probate inventories - an area that I have spent nearly thirty years working with.  

 

Conference attendees were welcomed by Lars Strannegard, the President of the Stockholm School of Economcs and keynote addresses were by Carole Shammas (USC)  titled "Why Did Finance Professionalize" and Phil Hoffman (CIT) titled "Dark Matter Credit".  Along with paper sessions, there were also two round tables.  On the Thursday, there was "The 'Market' as a Concept" which was moderated by Kristina Lilja (Uppsala) and the Friday afternoon saw "Women and Early Financial Markets" moderated by Ann McCants (MIT).  The conference wrapped by with a discussion and plans for future collaborative international research moderated by Anders Perlinge (Stockholm School of Economics).  

It was a lively, well organized and well attended conference with a lot of participation and interaction.  It was frankly rewarding to see so many researchers working in areas similar or parallel to mine and with similar types of data.  The strong resource base provided by Swedish probate records was particularly impressive and it is due to the hard work and initiative of Swedish researchers as well as generous research support.  The research into probate inventories as well as support for the conference comes from the Handelsbanken Research Foundation, the Wallenburg Economic History Foundation, the Marcus Wallenburg Foundation for International Scientific Collaboration, the Jacob Wallenburg Foundation, the Ebbe Kock Foundation, the Gunvar and Josef Aner Foundation, and the Swedish Foundation for Humanities and Social Sciences.  

Let me conclude with a warm thank you to our hosts and research supporters or as they would say in Sweden - tack så mycket - and end with a few pictures from the conference.

 

Ontario's Fiscal Paradox

My latest on Ontario's public finances...

Ontario has wrapped up its 2018 pre-budget public consultations as it prepares to deliver its next provincial budget. Ontario Finance Minister Charles Sousa confirmed in the fall fiscal statement that Ontario’s 2018 budget will be balanced, as will budgets over the next two years. However, the average Ontarian may be confused by the fact that despite a future of projected balanced budgets, the provincial net debt will continue to increase.

Indeed, recent years have seen the provincial debt grow by amounts exceeding that year’s deficit. For example, in fiscal year 2014-15, Ontario’s budgetary deficit was $10.315 billion but the net debt rose by $17.386 billion. In 2015-16, the deficit was $3.515 billion but $10.796 billion was added to the net debt. In 2016-17, the deficit was $0.991 billion but $6.276 billion was added to the net debt.
So how can this happen? See here for the rest of the post on the Fraser Blog...

A Brief History of Federal Budgets

The following op-ed appeared in the Waterloo Region Record, March 16^th, 2017 and the New Brunswick Telegraph-Journal, March 13^th, 2017.

The upcoming federal budget comes in Canada's 150th year — an important milestone for what is perhaps the most successful country in the world. The evolution of federal finances since 1867 reflects a changing economy and offers important lessons regarding the perils of persistent deficit spending and growing indebtedness.

Canada's federal government has indeed grown. In 1867, it had a budget of $14 million, an expenditure-to-GDP ratio of approximately five per cent, a net debt of $75.7 million, and a net debt-to-GDP ratio of 20 per cent. Transportation, communications and economic development accounted for a quarter of federal spending, and transfers to other governments 20 per cent. Meanwhile, debt service charges were 27 per cent due the newly formed federal government assuming provincial debts. There were no transfers to persons.

By comparison, total federal government spending in 2017 is estimated at $331 billion with an expenditure-to-GDP ratio of nearly 16 per cent and a net federal public debt of $760 billion, resulting in a debt-to-GDP ratio of 36 per cent. Assorted transfers to persons and other levels of governments now account for nearly two-thirds of federal government spending.

Until the First World War, customs duties dominated federal government revenue. The war effort sparked the search for new revenues leading to the creation of the first personal and corporate incomes taxes and the first federal sales tax. Over time, the importance of these three new revenue sources grew, and in 2017 it's anticipated that the personal income tax alone will make up 51 per cent of federal government revenue, with corporate taxes comprising 13 per cent and commodity taxes (GST, excise taxes and customs duties) making up 17 per cent.

The 150 years since Confederation have seen the federal government's primary focus transition from the active economic development of a country grounded in liberal economic principles to an activist role partly aimed at bringing about a more egalitarian society via social spending. Despite the benefits, expanded federal spending in the post-Second World War era — given the subsequent slowing of economic growth, rising interest rates and the absence of more concerted fiscal discipline — ultimately resulted in the 1990s federal debt crisis.

Prudent government spending is useful, such as the construction of the transcontinental CPR railway where subsidies encouraged the building of a risky transportation project. However, the same strategy also saw over-subsidization of the CPR and substantial subsidies to two other less-successful rail lines. More government spending is not always better, and that also applies to deficit financing.

Over the period 1867 to 2017, Canada's federal government ran a deficit nearly three-quarters of the time, with the largest deficits-to-GDP ratios during the two world wars and the great divergence between revenues and spending leading to the 1990s debt crisis. Large deficits and interest rates greater than the economy's growth rate during the 1970s and 1980s lead to a rising debt-to-GDP ratio and the federal fiscal crisis of the early 1990s.

The important policy decisions when it comes to spending are when to spend, what to spend, how much, and how to pay for it. The wrong answer to any of these questions has negative fiscal implications.

Given the surge in federal deficit financing in the wake of the 2016 budget, one wonders if the lessons of the 1990s have already been forgotten. While interest rates remain at historic lows, economic growth is also low, making a case for fiscal prudence given the dynamics of deficits and debt. The progress made in reducing the federal net debt-to-GDP ratio below 40 per cent will be largely squandered if we allow debt to once again grow uncontrollably.

Livio Di Matteo is a senior fellow at the Fraser Institute and professor of economics at Lakehead University. He is the author of “A Federal Fiscal History: Canada, 1867-2017.” Distributed by Troy Media