With the federal government acknowledging in its fall update this week that it has no timetable for balancing the budget, it bears repeating that contrary to popular belief, low interest rates do not justify deeper deficits. This is because interest charges are not the only cost associated with a deficit.
The federal deficit is rising, far beyond the $10 billion projected in the Liberal's election platform. The stated purpose of running $130 billion of deficits over five years is to stimulate the Canadian economy, whose prospects for growth are deteriorating.
Yet despite currently low interest rates, there are other considerations that must be kept in mind when thinking about the cost of deficits and infrastructure spending. For one thing, there is no guarantee that interest rates will stay at this extremely low level for very long. A sudden hike could raise public debt charges, which apply not only to the amount of the deficit, but to the substantial portion of the public debt that must be refinanced (this year, a total of $278 billion will be borrowed).
There is also the cost of taxes needed to pay debt charges, which this year amount to $25.7 billion, or 8.7 per cent of the federal government's budget. There is the cost of infrastructure maintenance, which represent a significant proportion of overall costs over the life cycle of an infrastructure project -- up to 80 per cent for some projects. There is the opportunity cost of government spending, since the resources redirected toward government projects are unavailable for private investments.
And there is the matter of the costs due to public sector pensions, which are rising. Our currently low interest rates, by making pension performance objectives more difficult to attain, entail additional costs of $3 billion a year. This erases a large part of the savings registered by the government thanks to lower public debt charges. In fact, the government finds itself already further in debt, before even borrowing an extra dime.
Instead of persisting in its plan to run up large deficits year after year with no end in sight, the federal government should instead take action to regain control of public spending. The cumulative federal debt is already worrisome, and represents a heavy burden for the next generation.
As for boosting the economy, increasing budget deficits as certain economists and interest groups are urging the government to do will only make matters worse. The best way to stimulate the economy is to reduce taxes and the regulatory burden, thereby removing obstacles for entrepreneurs, who are among the main engines of economic growth.
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Finance Minister Bill Morneau's new mortgage rules could "reduce the risk of a knock-on to the Canadian economy" from any possible corrections in Toronto or Vancouver, BMO economist Sal Guatieri told The Financial Post. The Bank of Canada has long warned that interest rates could go up again — and Canadians should ensure they can still afford to pay. Now they have to prove it to lenders.
First-time homebuyers tend to be the "primary users of mortgage insurance," according to Royal Bank of Canada. So the "stress test" could make it difficult for them to borrow as much as they'd like to. In a way that's a good thing. It means they can only borrow what they can afford. But it also means they won't have as much purchasing power in a hot market. That said, the new rules are probably protecting them from a debt burden they can't handle.
Home sales could fall as much as eight per cent in the first year after the new mortgage rules come into effect, Bloomberg reported. Of course, that depends on what buyers do. They may decide not to buy homes at all, they could also opt to buy cheaper properties, or dig into their savings just to afford their purchases, finance department spokesman Jack Aubry told the news agency. Meanwhile, the Bank of Canada says home sales could fall by as much as 10 per cent, while prices could drop by five per cent.
Stricter mortgage rules could mean that borrowers start turning to "shadow-banking," according to Canaccord Genuity. "Shadow-banking" refers to activities that happen outside traditional financial institutions. While bigger banks lend money using cash from deposits, shadow banks use money from groups of investors and aren't subject to the same scrutiny as major financial firms. They could therefore be more likely to hand out bad loans.
Canada's economy as a whole grew by $4.2 billion from the fourth quarter of 2014 to the second quarter of 2016, according to Macquarie Research. But residential investment increased by 3.5 times that amount ($14.7 billion) in the same time frame as housing activity skyrocketed in Vancouver and Toronto. Watch for residential investment to decline.
There are concerns that the new rules don't create an even playing-field for mortgage lenders outside the big banks, The Globe and Mail reported. Alternative lenders such as Home Capital Group, which generally target riskier borrowers with lower credit scores, may find themselves scrambling for business now that mortgage clients have to qualify for loans at higher interest rates.
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