I normally stay out of politics on this blog. But with the upcoming election, the political conversation on fiscal policy is starting to get stupid. In particular, for Paul Martin to accuse Stephen Harper of being the "King of deficits" was really stupid.
Is there anything Stephen Harper could have done to have prevented a fiscal deficit over the recent recession?
1. In my opinion, and it is a minority opinion, and one I came to only with the benefit of hindsight, he could maybe have prevented the recession if, before the recession, he had persuaded the Bank of Canada to switch from targeting 2% inflation to targeting (say) 5% NGDP level path. Forget it. You can't blame Stephen Harper for lacking a macroeconomic crystal ball.
2. He could have cut government spending or raised tax rates during the recession. He could have done that, but it would have been stupid to have done that. It would have been stupid on purely microeconomic grounds, even if it had not worsened the recession. Instead he did the opposite, and increased government expenditure, especially on long-term investments. Given the very low (negative) real interest rates, this was sensible on purely microeconomic grounds. I do not know whether loosening fiscal policy helped alleviate the recession. I am in the minority of macroeconomists who think that fiscal policy is not necessary for stabilising aggregate demand even at the Zero Lower Bound on nominal interest rates; but I might be wrong, and loosening fiscal policy at the ZLB was very cheap insurance in a country like Canada with a long run sustainable fiscal outlook (at the federal level). He did not start tightening fiscal policy until after the Bank of Canada had lifted off the ZLB, which meant it was perfectly possible for the Bank of Canada to offset any fiscal tightening, if the Bank of Canada thought it was needed. That was sensible.
Stephen Harper had the opportunity to do something really stupid with fiscal policy during the recent recession. He could have tried to balance the budget. He did not take that opportunity. Instead he did the opposite, which was sensible. And when you look at what governments in other countries did, saying that the Canadian government avoided doing something stupid is high praise.
"King of deficits" makes a great soundbite. The Toronto Star immediately grabbed it for its headline. So did the Globe and Mail, and the National Post. But it was the cheapest of cheapshots. It was a stupid accusation to make.
It was also a highly irresponsible accusation to make. Getting fiscal policy right is difficult, and not just a difficult economic question but a difficult political question.
Fiscal policy is difficult politically because we are trying to avoid temptation by committing to a rule of fiscal sustainability, while at the same time allowing that special circumstances do exist where it is not just permissible but responsible to break that rule. And the recent recession was one of those special circumstances. Responsible politicians would recognise that conflict between rules and legitimate exceptions, and would not muddy the distinction for partisan purposes. By making that partisan cheapshot, Paul Martin will make future fiscal policy worse.
(One other point I want to make in passing is that the current "debate" over whether the federal budget is or is not currently balanced is a silly debate. It's silly because it forgets to adjust the deficit for inflation. With a $600 billion debt, and 2% inflation, we could run a $12 billion reported deficit while holding the debt constant in real (inflation-adjusted) terms. And with 2% inflation plus (say) 2% long run real growth, we could run a $24 billion reported deficit while holding the debt/GDP ratio constant. This means there is currently a real surplus and a falling debt/GDP ratio. What we should instead be debating is whether the current real surplus is too large or too small, and whether the debt/GDP ratio should be falling more slowly or more quickly.)