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The economy continues to struggle to shift the engine of growth

One reason higher growth is not sustained in the government’s outlook is that the economy continues to struggle to shift the engine of growth from debt-financed household and government spending to exports and business investment. Increasing child tax benefits does not help this transition, especially when investment is being deterred by reports that NAFTA talks are floundering. In a recent interview, Bank of Canada Governor Stephen Poloz confirmed the bank has lowered its investment outlook as firms shift spending to the U.S.

The government attributes last year’s lower deficit to the boost incomes received from its stimulative policies. To assert that higher growth and a lower deficit were in response to fiscal stimulus means subscribing to the Laffer Curve premise that fiscal stimulus can pay for itself. No economist seriously believes this idea, three decades after it was first advanced. The lower deficit was the temporary result of the one-time factors that boosted growth, as well as difficulty in getting more infrastructure spending out the door. Windfall income gains should not be squandered on a structurally higher fiscal deficit. It is like a household winning the lottery and then spending so much that its debt load still rises.

Followers of macroeconomic policy-making were treated to a rare double header last week, with the fiscal update on Tuesday followed Wednesday by the Bank of Canada’s decision to leave interest rates unchanged. The decision to stop hiking interest rates is curious. The grand bargain of macroeconomic policy-making that the bank has offered for years was that excessive reliance on monetary stimulus would be withdrawn if fiscal stimulus were increased to take on some of the burden of supporting growth. For two years, we have had a marked move to fiscal stimulus, but only a tentative reining in of monetary stimulus. The bank declined to further increase interest rates last week despite higher federal budget deficits, leaving it to regulators to cool the overheated housing markets in Toronto and Vancouver.