Bank of Canada would only have had to raise rate to 3% if government spending hadn’t stoked inflation, say economists
Canadians will get a look at how Ottawa is managing its money when Finance Minister Chrystia Freeland unveils the fiscal update tomorrow.
“There is no question in our minds that fiscal policy has complicated the task of monetary policy in Canada,” said chief economist Jean-François Perrault and René Lalonde, director of modelling and forecasting.
“Interest rates are substantially higher than they would be had government consumption spending at all levels of government remained fixed in relation to GDP.”
“This has had a large impact on the economy. Put in a monetary policy context, the economy would not have been in excess demand were it not for this surge in government spending,” they said.
The economists calculate that government spending accounted for 120 basis points of the 475 bps the central bank has raised its rate since March 2022. Provincial spending was responsible for 70 bps of that, the Federal government 30 bps and municipalities and other levels of governments 20 bps.
COVID-19 relief to households accounts for about 80 bps, bringing the total impact to two percentage points.
The economists acknowledged the need for some increase in spending. Demands on government services have risen in recent years to cope with growth in the population and the increasing number of elderly Canadians.
“Some of the rise in government consumption of goods and services was likely desirable and necessary given population growth and ageing but those expenditures were inconsistent with inflation control and led to higher interest rates,” they said.
Fiscal policy can be a powerful tool to combat economic shocks, but it can also cause problems when that support is too big or goes on too long, said the report.
“This was definitely the case in Canada. Real government spending rose much more rapidly than real GDP since late 2019. There was nothing temporary about the surge in government consumption,” they said. “Pandemic transfers, on the other hand, were temporary but extremely large and kept in place too long.”
Scotiabank is the latest to flag concerns that government spending is making the Bank of Canada’s job harder.
Bank of Canada Governor Tiff Macklem has also urged lawmakers in Ottawa to consider how their spending will impact inflation.
Scotiabank economists say their research suggests that fiscal policy has been “badly mis-calibrated” since the pandemic regarding inflation management — and all levels of government are responsible for this.
“We quite literally cannot afford to repeat these errors in upcoming budgets,” said Perrault and Lalonde.
Mortgage debt rose 3.2 per cent from a year earlier to $2.14 trillion in September, the weakest pace of growth since 2001, said Statistics Canada.
That’s down from as high as 10.9 per cent at the beginning of 2022, making it one of the fastest decelerations in credit growth in data going back to the early 1990s.
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