Justin Trudeau’s government is telegraphing that its response to U.S. tariffs on Canadian exports could involve a return to COVID-19-era deficit spending. What is the Government of Canada’s fiscal position? How much money can it conceivably spend to blunt the economic effects of American tariffs, when it has engaged in large-scale debt-financed spending for a decade?
To explore this topic, regular contributor and economics professor at Lakehead University Livio Di Matteo joins The Hub’s program Up to Speed to share his analysis and insights.
The following is an automated transcript. If you are quoting from or referencing this episode, please refer to the audio to verify.
RUDYARD GRIFFITHS: Rudyard Griffiths here, the publisher of The Hub, welcome to this. Up to speed, our regular video series here on YouTube, where we’re providing quick commentary and analysis on breaking news and events. We do this each and every day, reaching out to some of our best contributors and thinkers, again, to bring you, hopefully, some new analysis and insights on breaking news, extremely fortunate to have on the program. Livio Di Matteo. Remind me of your university.
LIVIO DI MATTEO: I’m at the Lakehead University, Thunder Bay, Ontario.
RUDYARD GRIFFITHS: great old Thunder Bay Ontario. And you are a regular contributor to The Hub, and I come to you in The Hub for your analysis of economics finance, particularly debts and deficits and livid. Let’s begin there. I wonder what your reaction is to the news reports that have surfaced in the last 24 hours that the federal government of Justin Trudeau is considering what’s been characterized as pandemic COVID levels of spending, public spending in relationship to a potential us tariff on Canadian exports.
LIVIO DI MATTEO: Well, that’s an interesting policy response. I mean, my expectation would have been that the policy response would have involved some type of trade related counter measures, measures to boost productivity by removing provincial trade barriers to make more use of our effective market size, which is over 40 million people, a pandemic level response is a bit disconcerting, especially if you go back and review exactly what happened during the pandemic in terms of the size of the response.
RUDYARD GRIFFITHS: Now Livio, you’ve done some great work at the hub kind of breaking down Canada’s indebtedness, and you’ve often pointed out that, well, the federal government, in terms of a variety of metrics of debt to GDP or other things you might want to look at, unfunded liabilities, doesn’t stand up too badly versus other countries around the world. But the challenge in Canada is the extent to which we are heavily leveraged and levered economy with a lot of debt across provinces that have been equally profligate during COVID and after I’m what I’m struggling with livid is, how could the federal government and how could Doug Ford has now gone to the polls Here in Ontario with a premise that he needs a mandate to spend, in his words, tens of billions of dollars on a tariff response. How does that all happen? How do we have the opportunity to once again engage in a kind of debt spree? I thought there were some limits here, some economic I don’t know, walls that you could start to run into given this scale of spending over this period of time.
LIVIO DI MATTEO: Well, I mean, I think the best way to try to start to answer that is to look at exactly what happened during the pandemic. So if you go back to fiscal year 2019, 20, which is the year right before the big pandemic surge. Let’s just take the federal government, because the response of both governments during levels of government during the pandemic, the federal government was by far the larger amount of spending increase the provinces that increase their spending more, but a lot it was driven by federal transfers. So if you just focus on the federal government in 2019, 20, the federal government was spending about $363 billion in fiscal year 2021, which is, you know, the pandemic, which kicks in, you know, essentially just after the first quarter of that fiscal year, spending for that fiscal year goes up to $629 billion so essentially, spending went up by About $266 billion so the deficit went from, you know, 29 billion in 2019 20 to 312 billion, exceedingly large increase. The debt to GDP ratio basically went up 10 percentage points from about 36 to about 46% and the deficit the GDP ratio went from about, you know, 1.3% to 12% so, I mean, that’s a fairly significant increase.
And so if you’re looking at a COVID era, COVID level response, and you want to take that as the benchmark, that would be a rather large. Increase in our spending, if you start looking at some of the numbers, basically, if you did that, our deficit, which is at about 48 billion going into this fiscal year, would suddenly go up to well over 300 billion. Our net debt is at about 1.4 trillion, it would reach about $1.7 trillion and our debt to GDP ratio would probably go up from the current roughly 44% which is where we are based on the last federal economic statement, would go up to 54% okay, so I mean big no, that’s just from one year of spending, then the year after, spending did come down, but, you know, the deficit was still $90 billion and so it would be a fairly large fiscal hit. Can the federal government do it? Well, I mean, our debt to GDP ratio has been higher than 54% historically.
I mean, the one time where we hit the debt wall was in the early 90s, when we hit about 72 73% something like that. So there is room for that to a certain extent. However, it’s still a lot of spending. And I guess what you really have to watch out for is that when you look at that big increase in pandemic spending only. In the end, about half of it was for the pandemic in terms of either income support for workers affected by the pandemic and health spending. So a lot of that other spending was what seems, does seem to have been taken as an opportunity to expand the federal fiscal footprint, so to speak, through a variety of other programs. So I mean, going back about a decade, the federal spending, the GDP ratio, was at about 14% you’re now at about 17. There’s been a sort of permanent ramping up of the federal fiscal footprint. And so again, can we afford that? Well, I mean, as long as you’re able to borrow internationally, and I suppose you can.
RUDYARD GRIFFITHS: on that point, in terms of during the pandemic, was that the the Bank of Canada stepped in and through quantitative easing, purchased large amounts of of Canadian and provincial debt, artificially suppressing the cost of that debt, if it had had to have been sold into to domestic buyers and international buyers. And I guess my question is, with a with a depreciating Canadian dollar, with a growing spread between US and Canadian yields, because the American economy is much stronger. There seems to be a renewed threat of inflation. Their central bank is on pause. Ours is cutting rates. Livid. I just I guess, do debts and deficits matter? I mean, is it is this old school thinking to believe that bad things can happen when you spend too much, because right now, it seems as if our political class, both here at Queen’s Park in Ontario and in in Ottawa and the banks of the Rideau River, seem to feel that a lot of this is just, is consequence free, and that their Ambit, their freedom from action here, in terms of large scale spending and the 10s and hundreds of billions of dollars potentially, isn’t constrained. It isn’t constrained by the bond market. It isn’t constrained by interest rates. Am I missing something?
LIVIO DI MATTEO: Well, I mean, there’s always consequences to actions. If you look at the last run up in spending, I mean, look at what happened, you ended up with a rather large bout of inflation, and then interest rates had to go up to bring it down the really low interest rates through the quantitative easing that came about led to big flare up in housing prices. I mean, there was all kinds of consequences to the fiscal and monetary actions of that period now in dealing with the tariffs. I mean, history never repeats itself exactly. I don’t actually believe they’re going to engage in that same level of spending. I mean, if you look at the pandemic, GDP dropped about 5% during that one year. Employment dropped by 3 million people, but a lot of that employment drop was through lockdowns and other types of restrictions. It wasn’t exactly a response to a market downturn. So if the estimates of the impact of tariffs are to be, you know, taken at face value, you could see a drop in GDP of four to 5% but the employment impact will should not be as much. I mean, the sort of the worst case scenario for Ontario’s like a half a million jobs. Ontario’s roughly half the economy, so you’re looking at a third of the potential employment impact through the impact of tariffs. And so the response definitely should. Be at a pandemic level style. But what is unfortunate is that they are using the idea of a large pandemic style response to this. I mean, in a sense, we don’t really want to overreact on either the tariff response side or trade side or on the fiscal and monetary side to this, we first have to see what’s going to happen, and you can’t the day after suddenly decide you’re going to run $100 billion deficit.
I don’t really think that’s a responsible way of generating the policy response, because our policy response is going to have to shift, because what comes out of Washington seems to shift on almost an hourly basis. I mean, first there was going to be a 25% tariff, then there wasn’t, and then we’re going to review it in the spring. And now it’s going to happen Saturday. And now the last thing that just flushed across my iPad, well, it’s going to be a, you know, a two stage response. There’s going to be some tariffs, you know, this weekend, and then more tariffs later. I mean, honestly, I think the best thing most of our policy makers could do is just really zip up, borrowing from from Theodore Roosevelt. It’s really important to speak softly and carry whatever stick you can manage to carry to, you know, to beat this thing off and to stop publicly trumpeting whatever response you’re going to make, I think the Americans would get much more nervous if we suddenly went silent.
RUDYARD GRIFFITHS: Yeah, walk, walk quietly for them to carry a paddle, preferably a heavy one. Livio Di Matteo, economics professor, hub contributor, from Lakehead University. Thank you so much for coming on the program today and all your great writing and analysis at The Hub.