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Canada's Incredible Shrinking Deficit

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Good news! Canada's budget deficit is shrinking even before the federal government introduces its budget cuts.

Canada is the only major economy that has fully recovered from the 2008 financial crisis. More Canadians are working today than in September 2008. No other G7 country can say the same.

As the Canadian economy grows, tax revenues rise. As Canadians return to work, government spending drops.

Bob Plamondon crunches the numbers in his excellent blog:

"[F]ederal revenues were up $18.5 billion last year; a healthy gain of 8.5 percent owing largely to rising personal income taxes.

More good news was that, with less demand for EI benefits and the winding down of certain stimulus measures program, federal spending declined by $5.2 billion.

Unlike the previous year, where program spending exceeded revenues by $26 billion, the operating account for 2010-11 was essentially in balance. That left a deficit roughly equal to the debt charges of $31 billion.

Perhaps the best news in the government's numbers was that, with a $22 billion decline in the deficit, the federal debt-to-GDP ratio was held in check. In other words, despite incurring a deficit we are no worse off in relative terms."


Three caveats to this good news:

Caveat 1: Some of this good news is due to good luck: this global recession struck at a time when commodity prices happened to be high.

Caveat 2: The good news could turn bad. If the Chinese economy slumps, the prices of oil and grain and nickel could plunge, taking Canadian hopes down with them.

Caveat 3: Even if the good news continues, it is not sufficient in itself. Growth alone won't balance Canada's budget, new spending discipline will be required.

Caveats registered, though, here's an important lesson for the whole world from the Canadian experience:

When an economy is slump in deep recession, that economy's government will incur deficits. But it's very important to distinguish these recession-created deficits from long-term structural deficits. As the economy recovers, recession-created deficits shrink -- automatically.

That's why the bottom of a bad recession is a bad time to worry about deficits. The recession makes the deficit problem look bigger than it really is.

Worse, the actions a government might take to reduce its deficit -- cutting spending, raising taxes -- can prolong the recession. In which case, premature deficit-cutting can make worse the very deficits the deficit-cutters are trying to shrink.

Government budget deficits are not only a source of economic demand. They also counteract shrinkage of the money supply. The extra bonds created by a government deficits are often purchased by banks, where they expand the bank reserves that support lending to private businesses.

OK, OK, you know all this.

But even as you know it, serious people in the United States are overlooking this familiar fact -- and advocating actions likely to weaken America's already weak recovery.

Canada's success could be a useful corrective to this kind of misleading American thinking. The positive Canadian example can give Americans hope that their fiscal problems can be to a great extent self-correcting. The Canadian example can also give hope that as recovery accelerates, opportunities open to cut government spending at a more appropriate time.

A decade ago, American conservatives derided Canada as "Soviet Canuckistan." Now all is forgiven, even Medicare and the GST. Texas Gov. Rick Perry has built his jobs plan upon energy development, and Perry's supporters regularly cite the Canadian example as evidence their plan will work.

American conservatives would do well to learn from the Canadian example in its entirety. Deficit reduction must follow economic recovery. Get the sequence wrong, and you get neither recovery nor deficit-reduction.

This blog was previously published by the National Post.