Federal budget: Spending may fight inflation, not fuel it, Poloz says

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The rash of new spending measures unveiled in the federal budget on March 28 may not have the inflationary effect some are predicting because much of the money is being directed to adding capacity to the economy, according to former Bank of Canada governor Stephen Poloz.

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In a post-budget report, Poloz argues that the aggressive pace of central bank rate hikes over the past year are already having a cooling effect on overall demand, and supply side spending that boosts capacity should actually contribute to the fight against inflation.

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“It will be much harder to argue now that fiscal policy is still contributing to above-normal inflation and interest rates,” said Poloz, who now serves as a special adviser to the law firm Osler, Hoskin & Harcourt LLP.

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“Indeed, a budget focused on ‘investments’ arguably boosts the supply side of the economy — the child-care program or the completion of the TransMountain pipeline would fall into this category — which is not fiscal stimulus really, but more a disinflationary policy aimed at expanding economic capacity,” he wrote.

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Economists cautioned the department of finance to take a more conservative approach in the budget, saying excessive spending could make the central bank’s job in eliminating high price pressures much more difficult. It’s a plea that Finance Minister Chrystia Freeland addressed leading up to the budget, emphasizing a need to balance fiscal restraint with targeted measures.

But Poloz said it was too late for that.

“Arguably, that horse has already left the barn,” Poloz said. “If the government had reduced its fiscal stimulus a year ago, it would have meant fewer inflation pressures and a lower profile for Bank of Canada interest rates, and therefore less collateral damage to the economy — a missed opportunity to benefit many Canadians.”

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That said, Poloz suggested the government’s overall spending was manageable.

The $43-billion deficit for the outgoing fiscal year is lower than the $52.8 billion that was projected for this time in budget 2022. However, plans to balance the budget by 2027-2028 outlined in the Fall Economic Statement have gone out the window, too. Instead of a $4.3-billion surplus in 2027, a deficit of $14 billion is now being projected.

Running a persistent deficit, as long as it adds to government debt at a rate lower than the growth in the economy, gives the government wiggle room to bring new initiatives each year that could help Canada address its structural weaknesses, Poloz said.

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He noted that the degree to which these new measures tip the balance towards future inflation risks depend how the economy holds up when the new spending takes hold and how much these new measures contribute to future economic capacity.

“Given that the demand side of the economy is already slowing sharply and most of the effects of last year’s increases in interest rates have yet to appear, it is even possible that budget 2023 will help improve the odds of a soft landing in the economy, by buffering demand and boosting supply,” Poloz said. “Given the complexity of the situation, and the uncertainty around the outlook, it is simply too close to call.”

• Email: shughes@postmedia.com | Twitter: StephHughes95