Various numbers for projected deficits have been reported recently. This post tries to put those numbers into perspective.
The Canadian federal government will probably be running deficits in the near future. We could see deficits as a result of lower tax revenues if we go into a recession. Or deficits could be the result of a deliberate policy to lower taxes, increase transfers or government spending, to fight the recession.
Canada's GDP is around $1,600 in current dollars, and the federal debt is around $500 billion, so the debt/GDP ratio is just over 30%. (Actually, since about $50 billion of that debt is owned by the Bank of Canada, and the Bank of Canada is owned by the Government, and the Bank of Canada's liabilities are largely an accounting fiction, the debt/GDP ratio is really a little less than 30%).
It would take about 30% of our annual income to pay off the national debt. That is one useful measure of our debt-capacity.
The government is paying about $33 billion per year interest on the national debt. (Actually, about $2 billion of that is paid to the Bank of Canada, which the Bank then repays to the government, so it's really about $31 billion). $33 billion annual interest divided by $500 billion debt means an annual interest rate of 6.6%. That sounds high, but then remember that some of that debt is old debt, issued when interest rates were higher than they are today. Those interest payments will automatically come down as old debt matures and is rolled over at lower interest rates.
$33 billion annual interest payments divided by $1,600 billion GDP is about 2%, so we are paying about 2% of our national income as interest on the national debt. That is a second useful measure of our debt-capacity.
A continuously rising debt/GDP ratio, or interest/GDP ratio, is not sustainable. Eventually we would be unable to pay. A constant ratio is sustainable.
To see if a deficit is sustainable, there are two adjustments we need to make to any reported deficit: we need to adjust for inflation; and we need to adjust for real growth.
Inflation. If we run a deficit the debt will rise; if we run a surplus the debt will fall; if we run a balanced budget the debt will stay the same, measured in dollars. But in real terms, adjusted for inflation, it will not stay the same. The Bank of Canada has been targeting 2% inflation, and on average it has been hitting its target. So even if the surplus is zero, the real value of the debt will fall at 2% per year. 2% of the $500 billion debt is $10 billion. If inflation continues at 2% we can run a deficit of up to $10 billion and the real value of the national debt will still be falling.
Another way of looking at the inflation adjustment is to recognise that without that 2% inflation, interest rates on the debt would also be 2% lower, and $10 billion of that annual $33 billion in interest payments is really just an inflation adjustment.
Real growth. Even if the real debt were constant, rising real GDP will lower the debt/GDP ratio. Canadian real GDP growth has been around 3% per year on average. 3% of the $500 billion debt is $15 billion. If real growth continues at 3% we can run a deficit of up to $15 billion and the debt/GDP ratio will still be falling.
Putting inflation and real growth together, nominal GDP has been growing at about 5% per year, so the debt could grow at up to 5% and the debt/GDP ratio would still be falling. If nominal GDP continues to grow at 5%, we could run deficits of up to $25 billion and the debt/GDP ratio would still be falling.
In other words, once you adjust for inflation and real growth, we have actually been running much bigger surpluses than it would appear. The reported surpluses are only part of the story; inflation and real growth have been reducing the debt/GDP ratio.
But will inflation and real GDP growth continue? If we enter a recession, then by definition real GDP growth will become negative. And inflation will drop below 2%, and may even go negative. So even if we somehow keep a balanced budget (which we won't, and shouldn't even try to), the debt/GDP ratio will rise while the recession lasts. But as long as we feel confident that the Bank of Canada will restore inflation to the 2% target, and that we will recover from any recession, we should look beyond any temporary rise in the debt/GDP ratio, and subtract $25 billion from any reported deficit.
There is one bit of good news to consider: interest rates have been falling, and will stay very low during a recession. As government debt matures, and is rolled over at lower interest rates, this will reduce annual interest payments, and reduce any deficit. We see the maturity structure of the national debt here. About one quarter of the national debt is in very short-term treasury bills, which mature in less than a year, and another quarter matures in less than 5 years. So we can expect to see a big fall in the $33 billion of interest payments. That should help a bit.
And if the recession gets bad, and the Bank of Canada gets aggressive in quantitative easing (printing money to buy government bonds and other assets), a larger proportion of that $33 billion interest payment will go to the Bank of Canada, and will be returned to the government.
And money-financed deficits will be financed at 0% interest.
Worthwhile Canadian Initiative 
Slightly OT but any thoughts on the fact that Harper’s economic advisory council appears to have only one economist (Jack Mintz)? Also, I propose that from now on, anyone uttering the assinine phrase “technical recession” be simultaneously subjected to a wet willy, indian sunburn, purple nurple and a wedgie.
I would say the set of ‘technical recessions’ is probably a subset of ‘true’ recessions, rather than the superset people seem to be suggesting when they use the term.
You owe me one keyboard cleaning, ramster!
I never understood what a “technical” recession was until I was long past my PhD. And then I only learned it from a newspaper. It’s defined IIRC (and it is just so unimportant for me to remember it correctly) as “2 successive quarters of negative GDP growth”.
I dislike (hate?) the concept. It is so non-useful. It is so arbitrary. It gives a totally misleading sense of precision. It would be like trying to define “bald” as “having fewer than 42 hairs on one’s head” (Wittgenstein’s example, I think, except for the “42”). Some useful concepts/distinctions are nevertheless imprecise, and should stay that way. It suggests that there is some important distinction between +0.001% and -0.001% GDP growth, that’s not there between +0.002% and +0.001%.
In the US, again IIRC, the NBER has set itself up as the “official” arbiter (who says?) of what is and is not a recession. OK, they look at more stuff than just GDP, but even so, the exercise is pointless. Can you imagine some official body of barbers arguing over the precise dividing line between bald and hirsute? It’s pointless. “Recession” is a useful and meaningful but fuzzy concept, just like “bald”.
Jack Mintz is a very good public finance economist, and I’m glad he’s on the team. But he is a micreconomist, not a macroeconomist. I’m a bit surprised there’s not a macroeconomist there as well. On the other hand, maybe Finance has plenty of good macroeconomists already (I can think of at least one who is excellent), so was going outside to gather the expertise it doesn’t have internally.
The composition of the council is probably meaningless. Practically every economist in Canada argued that consumption taxes were preferable to income taxes yet that didn’t stop them from cutting the GST. I expect that any economic stimulus policy will largely be directed by political calculations. Though misguided, I suspect that the GST cut was popular. I also doubt that the big-brains in finance have much of an impact on any real decisions.
I’m amazed that more people aren’t getting an extreme case of whiplash from the PM’s statements over the last few months. Here’s a chronology:
October: “probably some great buying opportunities out there.”
November: “the most recent private sector forecasts suggest the strong possibility of a technical recession of the end of this year”
November: 800 million dollar surplus in 2008/2009 (Economic and Fiscal Statement)
December: “The truth is, I’ve never seen such uncertainty in terms of looking forward to the future,”…on the possibility of a depression, “it could be”
December: “Some people are talking in the neighbourhood of a $5- to $10-billion deficit. Our own assessment is frankly that will not be sufficient given the challenges we’re facing…I think what will be more realistic in terms of the kind of stimulus our economy is going to need is going to be in the $20-billion to $30-billion range.”
And that’s from about 10 minutes of google-mining. Well I guess we can at least be consoled by the fact that the PM isn’t ideologically hidebound and is willing to dump the Hoover-ism when necessary. It’s a good thing we don’t have a PM who panics!
I also enjoy how this panel fulfills yet another item on Dion’s ’30 day plan’, except it took Harper over 60 days to implement. But remember, that plan was panicking.
Considering the threat of deflation, is a money financed deficit the first option right now or is the low-borrowing cost on government debt more attractive?
Wow – now my post looks off topic.
Who needs macroeconomists on an advisory panel when you can have rich white guys and Canada’s own Sarah Palin (Carole Taylor).
The IMF and OECD both peg Canada’s debt to GDP ratio at approx. 60%. This is a long way from the 30% you quote. Why the discrepancy?
Sargasso: I think that must be for the combined federal plus provincial debt/GDP. I did a quick Google search and found 2005-6 total provincial debt/GDP ratio of 35%. http://blog.scott.tylers.info/index.php?/archives/49-Provincial-Debt-Table.html . Assuming it’s dropped 5% since then, we get the same numbers: 30% federal +30% provincial = 60% combined debt/GDP. It does make sense to look at combined federal + provincial debt for a solvency perspective (though why not add municipal as well?), but for my purposes, trying to get a feel for the federal deficit, it made more sense just to look at the federal debt.
brendon: from a “cost of borrowing” perspective, it makes little difference if deficits are bond or money financed in the short-term, since interest rates are so low. From the perspective of escaping a liquidity trap, money finance is better, since if the increase in the money supply is assumed permanent, money finance increases expected future inflation (and increases net wealth) by more, so has a bigger and more certian stimulus to aggregate demand.
Sargasso: I think that must be for the combined federal plus provincial debt/GDP. I did a quick Google search and found 2005-6 total provincial debt/GDP ratio of 35%. http://blog.scott.tylers.info/index.php?/archives/49-Provincial-Debt-Table.html . Assuming it’s dropped 5% since then, we get the same numbers: 30% federal +30% provincial = 60% combined debt/GDP. It does make sense to look at combined federal + provincial debt for a solvency perspective (though why not add municipal as well?), but for my purposes, trying to get a feel for the federal deficit, it made more sense just to look at the federal debt.
brendon: from a “cost of borrowing” perspective, it makes little difference if deficits are bond or money financed in the short-term, since interest rates are so low. From the perspective of escaping a liquidity trap, money finance is better, since if the increase in the money supply is assumed permanent, money finance increases expected future inflation (and increases net wealth) by more, so has a bigger and more certian stimulus to aggregate demand.