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Deficit Despair Awaits Canada
World Economy

Deficit Despair Awaits Canada

A speedily aging and shrinking workforce is one of the more certain new variables that Canada’s finance minister, Bill Morneau, must toss into the mix as he imagines the future impact of the deficit he plans to run up in next month’s budget. Other variables are not so clear.

It may be no more than a persistent illusion, but it feels as if this time the global economy in general—and Canada’s in particular—really are on the precipice of greater-than-usual uncertainty, CBC reported.

While there are many changes a wise government can make to adjust for unexpected eventualities, deficits represent an enduring shackle to an unknown future. There are good reasons why this matters.

Just like maxing out your first credit card, running a government deficit is easy. Paying it off is not.

Most economists agree there is nothing wrong with carrying a federal debt of between 25 and 35% of GDP, especially while interest rates are so low. But running repeated deficits larger than the growth rate of the economy, popular as it may be while governments are doing it, can quickly accumulate into something far less manageable.

 Spending Cuts

According to conventional economics, governments have two options to get rid of debt. Both require a cutback in spending. One is to freeze spending while waiting for the economy to outgrow the debt. Unfortunately a freeze feels like a cut, since spending must be reduced by the amount of the previous year’s deficit.

The more urgent way to reduce debt is to take an axe to spending—as we saw after the federal debt peaked in 1997 at about 65% of GDP—or raise taxes. As politicians have learned time and again, there is never a good time to slash spending or raise taxes. It makes voters mad.

Besides the great difficulty of unwinding a deficit once it exists, there are other reasons Morneau must be wary of how much he is willing to borrow. One is the whole concept of a return to normal growth.

As Bank of Canada Governor Stephen Poloz has reminded repeatedly, one way of calculating growth is production per worker times the number of workers. But as the boomer cohort leaves the workforce, the number of Canadian workers is expected to shrink, a little at first, then much faster in about five years, as midpoint boomers, born in 1955, hit the traditional retirement age of 65.

As we have seen in countries like Japan that have led the way on an aging workforce, normal growth rates are much lower than they were when large numbers of young families were nesting and buying things for the kids. It may be that growth rates averaging between the 1-2% that is being currently experienced are not so bad.

Morneau says that without deficit spending, Canada may head into recession.

 

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