BUSINESS

Why A Balanced Budget Law Could Mean More Debt For Consumers

04/13/2015 08:25 EDT | Updated 04/13/2015 12:59 EDT
CP

The Conservatives’ proposal to mandate balanced books “during normal economic times” for future governments could paint the economy into a corner, potentially allowing the government to reduce its debt at the price of encouraging consumers to increase theirs.

On the eve of plans to announce the first balanced budget in eight years — and after much finagling to make it so — Finance Minister Joe Oliver confirmed last week that the government will bring in balanced budget legislation.

In doing so, the government made good on a 2013 throne speech pledge to invoke legislation requiring “balanced budgets during normal economic times, and concrete timelines for returning to balance in the event of an economic crisis.”

The law, though potentially toothless, may require the country’s central bank to adopt even easier lending policies to offset a government spending clampdown.

“The balanced budget rule is basically just formalizing what the Canadian government has been doing anyway — trying to run surpluses during good times and running deficits to stabilize the economy during bad times,” said Krishen Rangasamy, senior economist at National Bank.

The Harper government’s announcement came the same week the IMF urged governments around the world to be more responsible with their fiscal balances in a new report.

“You need healthy public accounts that can take hard hits during severe storms. But most importantly when sunshine returns, policy makers must repair the damage to public accounts in preparation for future storms,” the global monetary institution said on a conference call.

canada budget balance

Little breathing room

But some economists believe it’s time for the government to bring in more stimulus spending rather than austerity amid low Canadian economic growth and an unemployment rate of 6.8 per cent with little sign of near-term improvement.

The legislation will put pressure on the Bank of Canada to keep interest rates low for longer even after a recession in order to stimulate demand in the economy that might otherwise be sparked by government initiatives, Rangasamy said.

But the Bank of Canada might find itself with little room to move in an era when it has said low interest rates are likely already the new normal.

In 2008, when recession hit, the overnight lending rate was three per cent, giving the central bank ample room to maneuver. It came down quickly and has hovered at one per cent or less ever since.

Introducing the bill at a time of slow economic growth, when the interest rate is already near record lows at 0.75 per cent, could tie the hands of central banker Stephen Poloz when it comes to providing more stimulus. Some economists already believe the banker’s next move will be to lower rates further and at least one believes that move could come as soon as this week’s policy announcement.

“It does become an issue if interest rates are already low. The central bank may not be able to provide the kind of stimulus necessary to promote a quick recovery,” said Sal Guatieri, senior economist at BMO.

The central bank does have other tools at its disposal, including quantitative easing or printing money, he added, but those are more extreme and unusual measures.

After years of consumers growing used to cheap credit, Canadian home prices are sky high while debt-to-income ratios sit at a record high of 163 per cent.

At the end of last year, the Bank of Canada’s main economic concern seemed to be household debt levels sparked by the prolonged period of low interest rates.

Household imbalances...present a significant risk to financial stability,” it said in its last policy update of 2014.

But all of a sudden tanking oil prices overtook household debts and the bank decided to lower interest rates again in the opening months of 2015. Another reason to keep interest rates low, such as the balanced budget bill, could cause further damage to household finances, Guatieri said.

“If household debt is already quite elevated, the central bank has to be cautious because the more it pushes down interest rates the more it will encourage borrowing and a buildup of debt and that in itself can pose problems with the economy.”

The Parliamentary Budget Officer warned in a report last year that a balanced budget mandate should not be applied too literally, and instead allow flexibility to consider what is in the best public interest at any given time.

Reining in government spending during times of slow growth could actually worsen a bad situation, while easing monetary policy allows more Canadians to add to their growing debt loads, said Lisa Philipps, professor of taxation law and fiscal policy at Osgoode Hall Law School.

“Once they commit themselves to a balanced budget they inhibit themselves from doing what is economically sensible to shorten a period of economic weakness rather than worsen it,” she said.

“My whole understanding of countercyclical fiscal policy is government’s supposed to push the opposite way from the way the private economy is going.”

A 'Distortive' Law

But in reality, Philipps believes the bill is just political optics that future governments can easily eschew. She added that many provincial governments — including B.C., Alberta, Ontario and Quebec — have instituted such legislation, and many of them have simply amended it to make exceptions when they need.

“They’re not really strictly enforceable in a legal sense, or they haven’t proven to be so far, so really all they do is they factor into the politics,” she said, adding that studies from other countries with similar legislation, such as the U.K., Australia and New Zealand, suggest the economic effect is either neutral or negative.

“It’s just distortive frankly to put it into law, its not something you can predict,” she said, noting that the budget is just a projection based on assumptions that can turn out to be wrong and the pressure to present a balanced budget could lead to inaccurate calculations.

“When we see how fast things change — it’s just crazy since 2008 — and we can’t anticipate what the economy’s going to do next, we’re putting too much weight on holding governments to their plan.”

Ultimately, the extent to which this legislation will impact the economy depends on the government’s wording of the bill — how much flexibility they build into it and how it defines “normal economic times” because, especially now, there is a lot of grey area, Guatieri said.

“Rarely are we in normal economic times.”

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