A large deficit is inevitable but very manageable

Right now, federal, provincial, and municipal governments, the private sector, and all Canadians are implementing a counter-cyclical policy aimed at “shutting down the economy” in order to halt the COVID-19 virus. Successful implementation of this policy is critical to eventually restarting the economy. This is true of fiscal costs will be temporary and manageable. They are not something to worry about now.

The federal government delivered its Economic Response Plan (ERP) on Tuesday, providing $27.4 billion in direct time-limited support to low- and middle-income Canadians and to small businesses, along with another $55 billion in income tax deferrals. The government also promised that special support would be provided to the airline and resource sectors in the next few days. Both the Prime Minister and Minister of Finance promised additional measures if required. In all likelihood more support will be required.

This ERP is a credible plan. It is a flexible plan that allows its critical parameters to be changed quickly if needed. The $27.4 billion represents only 1 per cent of nominal GDP. However, some of the measures will have little impact. For example, the $55 billion in tax deferrals will need to be paid; for individuals by June 1, 2020 and for businesses by August 31, 2020. These deferrals should have no or little impact on the deficit, provided Canadians and Canadian companies owing taxes have the required funds in June and August. Many small and medium sized businesses will have been forced to close or restrict their businesses so that this measure will not help them.

The problem with the ERP is that it is too short term. It is based on the unrealistic assumption that the “curve” will be flattened very quickly and the infection rate will be falling within three months. These assumptions are reflected in the ERP. Many of the income support initiatives are one-time payments or income support that lasts only 3 months.

But health care specialists and scientists simply don’t know how the COVID-19 will behave in the coming weeks and months. This means that the ERP will have to be extended for another three or even six months. This can be done quickly without a temporary loss in income support given that the changes to the EI and the CRA programs are already in place.

It won’t be long before people will start asking about what all this will do to the deficit. The December 2019 Economic and Fiscal Update (Update) forecast a deficit of $28.1 billion for the current fiscal year. That was before COVID-19 and the sharp decline in oil prices. This has now been increased by $27.4 billion to $55.5 billion, assuming only $27.4 billion will be required and the economy rebounds quickly after one quarter. But it could be much higher if the ERP is in place for nine months, rising to $110 billion (4% of GDP).

But this ignores the impact of shutting down the economy. Right now no one knows. Private sector economists are all over the map as to what could happen over the next 12 months. Some are forecasting a decline in real GDP for one quarter only, others for three quarters. Some expect only a marginal decline in GDP, while others expect double-digit quarterly declines.

The government would be wise not to table a budget or even an Economic and Fiscal Update at this time. This would be prudent and quite understandable in the current circumstances. We are living in a world of complete uncertainty both globally and domestically. The current health and economic environments are intertwined and extremely volatile. Quarterly economic data for the first quarter will not be available until May and for the second quarter until August, although monthly data published in the interim will provide an indication of what is happening.

During the 2008/2009 financial crisis, the deficit in 2009/10 reached $56.4 billion of which $18 billion was attributable to the stimulus measures, meaning that economic developments amounted to $38.4 billion of the deficit outcome. Real economic growth declined for three consecutive quarters, by 1.2 per cent, 2.3 per cent and 1.1 per cent, respectively.

If the economic impacts were similar, this would result in a deficit of $93.9 billion for 2020-21. However, GDP is much larger now than in 2009. In addition, the impact of COVID-19 on the economy is likely to be much greater than that of the financial crisis. Finally it is very likely the government will have to extend the policies announced to date to the second half of 2020-21. This could add another $55 billion to the deficit. A deficit of $150 billion (6% of GDP) or higher is very possible.

But this is a manageable deficit. It is a cyclical deficit, not as structural deficit. It can be eliminated relatively quickly once the COVID-19 is halted in Canada and other countries, the global economy and domestic economy begin to recover and temporary anti-virus policies are removed.

C. Scott Clark held a number of senior positions in the Canadian Government, including Deputy Minister of Finance from 1998-2001. He has a PhD in Economics from the University of California at Berkeley and is currently President of C. S. Clark Consulting.

From 1990 to 2005, Peter C. DeVries served as Director, Fiscal Policy Division, at the Department of Finance. In that capacity he was responsible for overall preparation of the federal budget. He is currently a consultant in fiscal policy and public management issues.

Their Blog is 3dpolicy.ca