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The formula for the critical level is quite simple: the current debt level times the growth rate of GDP. So if GDP is growing at 4.5% a year and the debt is $700 billion, the maximum size for a modest deficit is 4.5 per cent of $700 billion, or $31.5 billion. To the extent that these back-of-the-envelope numbers are roughly consistent with our current situation, even a deficit of $14 billion could still be considered modest. Playing this game involves a certain amount of risk, though. Interest rates are expected to increase over the next few years, and this will put additional pressure on the deficit.

But to my mind, the bigger risk lies elsewhere, in the provinces. As a group, the provinces ran bigger deficits than the federal government during the recession. But while Ottawa managed to eliminate its deficit over the past four years, provincial governments are still running a collective deficit in excess of $40 billion a year. So while the federal debt-to-GDP ratio has declined since 2011, the provincial ratio has been climbing steadily and has now surpassed the federal ratio for the first time. (This asymmetry cannot be explained by a reduction in the payments Ottawa sends to the provinces; federal transfers under the Conservatives continued to increase in line with the growth of the economy.)

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The net result of these two trends is a general government debt ratio that has held roughly steady in the past few years. (The “general government” category includes the CPP/QPP pension funds, and since some of their assets consist of government bonds, general government net debt is less than the sum of the federal and provincial debts.) If you consider the provinces – and you should – Canada is already running a deficit that is consistent with a stable debt-to-GDP ratio. To be sure, the situation varies from province to province, but it’s still a mistake to make fiscal policy based on the assumption that only the federal government matters.

The extra expenditures that the Liberals are planning may not be enough to increase the federal debt ratio (although they may yet, if economic growth and interest rates don’t cooperate), but they will very likely increase the total Canadian debt ratio. In the interests of modesty, the Liberals should revisit the size of their fiscal agenda.

National Post

Stephen Gordon is professor of economics at Laval University.