09/16/2015 05:06 EDT | Updated 09/16/2016 05:12 EDT

Cutting Deficits As BoC Lowers Rates Makes No Sense, Economists Say

OTTAWA — Imagine a Calgary Stampede chuckwagon team pulling in two directions at once.

As the three federal party leaders gather in Calgary for Thursday night's crucial election debate on the economy, some of Canada's most experienced fiscal policy analysts say a fundamental incoherence in the federal government's growth strategy is being all but ignored.

While the Bank of Canada has already cut rock-bottom interest rates twice this year in an effort to spur the sputtering economy, Ottawa has been yanking the reins by continuing a five-year squeeze on federal government spending.

"Our current policy mix is wrong," David Dodge, the former governor of the Bank of Canada, said in an email from Europe on Wednesday.

"Not enough federal support for growth, so the bank has to shoulder too much of the burden, as do the provinces."

Dodge has been banging this drum for at least a year, arguing the politically driven timetable for returning to balanced books has been a drag on the economic recovery. He's not alone.

Kevin Lynch, who served as the powerful clerk of the Privy Council for Prime Minister Stephen Harper's first three years in office, questioned why fiscal policy is being ignored in an op-ed in the Globe and Mail late last month.

"Ottawa, we have a policy-mix problem," wrote Lynch, the vice-chair of BMO Financial Group.

Interest-rate cuts when rates are already below 1.0 per cent may have limited power to spur further investment "and may create ongoing distortions," said Lynch, such as fanning an already overheated housing market. Rate cuts don't solve structural growth problems, he argued, while curbing discretionary government spending "has actually been contractionary."

Former senior Finance Canada official Don Drummond, who helped craft the deficit-slashing federal budgets of the mid-1990s, sounds exasperated that politicians and the financial press appear to be ignoring the conflicting fiscal and monetary policies.

"The Bank of Canada says there's an output gap," Drummond, a distinguished visiting scholar at Queen's University's School of Policy Studies, said in an interview.

"They are going to extraordinary lengths — and causing some problems in going to those extraordinary lengths by absolutely hampering the incentive for people to save, which is not a good thing to do — and to some degree offsetting the fiscal hit."

Drummond flatly questions whether it is "even valid to have a surplus at this point," and suggests Stephen Poloz, the governor of the Bank of Canada, "would probably say no," if he were free to speak his mind.

Poloz is delivering a speech Monday in Calgary, where he most assuredly will not wade into the debate over government surpluses versus deficits.

Justin Trudeau's Liberals are the only party openly embracing deficit spending in this election, with a proposal to run annual shortfalls of up to $10 billion for three years to finance a major infrastructure program.

Trudeau asserted this week on the campaign trail that the Conservative government's push to balance the books — the government officially posted a marginal surplus of $1.9 billion in 2014-15 — helped cause this year's technical recession. The claim prompted the usual eye-rolling from pundits. 

Craig Alexander, the vice-president of economic analysis at the C.D. Howe Institute, noted that this week's release of the 2014-15 Annual Financial Report showed that federal government expenditures rose 1.3 per cent last year, which was less than the rate of inflation.

"The government sector in calendar year 2014-15 was acting as a bit of a drag," said Alexander. "The impact was very small and it was there to achieve a particular goal, which was balanced budgets."

It's that balanced budget orthodoxy that Dodge, Lynch and Drummond question.

Drummond says people seem to place deficit-fighting and fostering economic growth in distinct policy silos.

"Well, they are linked," said the economist.

"We had a $58-billion fiscal turnaround in the space of five years. That's over $11 billion (in spending cuts) a year. Over half a per cent of GDP was withdrawn from the economy every year. Well I'm sorry, that has an economic implication."

"That's one of the reasons why the economy is weak. I'm just amazed that no one connects the economic and the fiscal part of it."