"King of deficits"??

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.)

Comments

[Mark_dowling]

I agree with you that making deficits a partisan issue isn't necessarily helpful, but given choices made by this government while simultaneously wrapping themselves in a sales pitch about economic prudence compared to the spendy left (of the CPC party rather than a nominal political spectrum) it's not irrelevant to discuss it either.

"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."

He did narrow the tax base by taking two points of GST and introduced boutique tax credits while still claiming to have a plan to not run/eliminate deficits. Because that's what works politically when you have a lot of advertising money to tell people a story which doesn't have to be audited by the PBO.

As for a falling debt/GDP ratio, it doesn't take long for that to go the other way with the right conditions. Ask Ireland.
http://www.tradingeconomics.com/ireland/government-debt-to-gdp

[Chris]

Your last point ("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.") is nonsensical. If you want to adjust the deficit for inflation, you ALSO have to assume that expenses will rise with inflation.

[Sandwichman]

I normally stay out of defending Stephen Harper in any way, but the Liberal message seems oddly self-contradictory with Paul Martin attacking Harper over deficits and Just-in Trudeau attacking Mulcair over austerity. Can they have it both ways?

[Ken Howe]

I'd really appreciate it if you'd write a letter about the subject of your closing aside to as many newspapers as you can (perhaps you have already). I've written the same thing to a number of them (Le Devoir, the Kitchener-Waterloo Record, the Globe) without success, but perhaps am easier to ignore since I'm not an economist.

[Andrew_FL]

"Given the very low (negative) real interest rates, this was sensible on purely microeconomic grounds."

Aren't you reasoning from a price change?

[Jim Sentance]

I'd agree with most of this, with a few quibbles. Like Mark, a lot of people point to the GST cuts as an issue, but then the other parties were also talking tax cuts at the time, just different ones, so while I might criticize Harper on his choice of the GST to cut, its harder to blame him for the pre- recession tax cut. The ones since, mostly stupid boutique tax credits and income splitting I would critique. We'd probably be in a balanced budget (a real one, not one based on accounting tricks) now if they'd resisted these - though I'd agree with you that this close, its not really a concern.

Unlike you I don't give him a lot of credit for making the safe move to stimulus after the recession (though I agree it was a fair move) because I don't think he would have done it without the gun of a threatened opposition coalition government to his head.

[Bob]

The debate is mindless. Similar mindless debate in Australia. Nobody asks WHY?
http://bilbo.economicoutlook.net/blog/?p=31687
The budget balance should never be a goal. Goals are things like full employment (jobs), healthcare, taxes, education and arguably price stability (inflation.)

[Bob]

"We'd probably be in a balanced budget (a real one, not one based on accounting tricks) now if they'd resisted these - though I'd agree with you that this close, its not really a concern."
That doesn't work either. Japan raised sales taxes recently and the economy fell into recession.
It's all "accounting tricks." The deficit is an ex post accounting abstraction determined mostly endogenously and depends on private sector decisions to spend and save.
If the government spends it will get ALL its money back if there is no saving in the spending chain. Even if the tax rate is 0.5%. Think about that for a couple of minutes. It just means more real activity takes place - which may cause inflation if it outstrips the real capacity of the economy.
If you have aggregate net saving you will have deficits.
Raising taxes or cutting spending may not reduce the "deficit." Do it when you have high inflation to free up real capacity.

[Nick Rowe]

Mark and Jim: I agree that cutting GST was not a good policy; there are worse taxes he could have cut instead, and I don't like those little boutique tax credit things which have high administrative costs. One maybe defence of the GST cuts: it's the provinces, not the feds, who have unsustainable fiscal policies, and you could maybe argue the provinces could and should have raised their own PST 1% or 2% to replace the federal GST cuts.

Andrew: In an individual experiment ("what should an individual do, if the real interest rate drops?") it is correct to reason from a price change. It wasn't (I'm pretty sure) a shift in the Canadian government investment demand curve (Benefit/Cost of investment curve) that caused world real interest rates to drop, in this case. Scott's point is theoretically correct, but in my judgement does not apply here.

Bob: I have read Abba Lerner. I disagree. It is the responsibility of monetary policy to ensure the correct level of aggregate demand. That leaves fiscal policy free to pursue other objectives, and long-run sustainability of fiscal policy is a constraint, in an overlapping generations world, or the young won't buy the bonds off the old.

[Nick Rowe]

Chris: We should adjust everything for inflation, including government spending. That is not nonsensical. It helps us think more clearly, if the value of money is falling at 2% per year, so our measuring stick is getting 2% shorter every year.

[djb]

Nice article

By the way who owns all those newspapers you mentioned

Apparently, more than ever, the oligarchs believe macroeconomics is the same as microeconomics

[Nick Rowe]

For non-Canadians reading this: Stephen Harper is the current Conservative Prime Minister, and Paul Martin was the Liberal Finance Minister who lead the 1995 tightening of fiscal policy which converted a large budget deficit into a budget surplus. What's ironic is that many Canadians accuse Stephen Harper of being some sort of right-wing extremist, and I love to tease lefty Keynesians in other countries that they would have loved our extremely right-wing Conservative fiscal policy over the recent recession.

It is probably important that: Stephen Harper has an MA in economics (he's not a lawyer!!); Canada had a fiscal surplus and low debt/GDP ratio going into the recession; at least in my view, there seems to be a consensus in Canada that long-run fiscal sustainability is important and I'm reasonably confident that we can let ourselves lighten up in special circumstances without falling off the wagon permanently. It is different in some other countries. (The provinces are a different matter.)

[Jim Rootham]

To give credit where credit is due, running a higher than usual deficit is a good idea at the moment and I am right pissed at my party at the moment.

[Nick Rowe]

Jim: "...running a higher than usual deficit is a good idea at the moment..."

I think that's a bit of a judgement call. It depends on whether you think the economy at the moment (2015?) is performing at about the average level, or below average. (Question: Does the drop in oil prices affect *federal* revenues much? and is that temporary?) But if it's below average, then I agree.

[Chris J]

Nick, Maybe this is what you meant by Martin's comment will make "future fiscal policy worse" but this obsession with deficit is annoying. Shrinking our total debt to GDP is useful for being ready for the next shock but now may or may not be the right time to do it.

There is a false sort of mortality in this. The zero deficit thing is a sort of moral scolding. It is not (necessarily) economic thinking.

We also have some work to do that will cost some cash up front. It is about bloddy time we seriously rethink how broader Canadian society works with aboriginal Canadians. And we need to seriously push for energy that won't change the climate. Those two alone will have long term payoffs but short term costs.

Run a deficit!

[Chris J]

Mortality -> morality

[Nick Rowe]

Chris J: that's sort of what I meant, but not exactly.

I do see deficits as a question of morality. The wrong level of deficit/surplus has bad consequences, and changes in deficits/surpluses do redistribute benefits/costs across generations. (Though knowing what the right deficit/surplus is is not an easy question to answer, and we need economics to try to help answer it.)

If Canadians were like a bunch of debt alcoholics, who were unable to take a single drink without getting permanently wasted, I could see the point of a very strict moral rule of avoiding temptation of deficits regardless of circumstances. But, as the last few years shows, we are not like that. Harper's government ran a deficit for a few years, when circumstances warranted, and then stopped, and is now (I think) bringing the debt/GDP ratio back down to (roughly) where it was before the recession. I think that is a much superior moral rule to either: never take a drink ever; get permanently wasted. It's a very responsible approach to deficits. And if you accuse someone who takes a few drinks at parties and then sobers up afterwards of being the King of alcoholics, future governments will either never run deficits (bad), or say "that's stupid, and I might as well get hung for a sheep as a lamb" and get permanently wasted (even worse).

[Nick Rowe]

Chris: sort of like this old post, only I would need to re-write it to talk about a long run debt/GDP target, rather than a price level target. Having a long-run debt/GDP target allows the government to declare "special circumstances" in any particular year, but they can't keep on declaring "special circumstances" year after year. I think it's a good compromise. Having an arbitrary debt/GDP target is more sensible than having an arbitrary zero deficit target.

[Avon Barksdale]

Nick,

"Getting fiscal policy right is difficult, and not just a difficult economic question..."

Suppose that government spending made up less than 10% of GDP. Would fiscal policy then still be such a difficult economic question? Why do we need government to spend about half the national income?

[Nick Rowe]

Avon: it would still be an equally difficult question, but it wouldn't matter as much if we got it wrong, percentage-wise.

[Tom Brown]

"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."

Well, that beats the situation here in the US, where the political conversation on just about every subject has been pegging both the stupid and the bullshit meters for years now if not decades.

I don't have a clue about Canadian politics, but I'm 95% certain we'd be better off if we traded you all our politician for yours (of course then we'd have to build a wall so you couldn't change your minds) (kind of like trading in all your tiles in Scrabble, because you figure it really can't get much worse). Actually, I'm not sure that would work... the main problem seems to be the electorate.

If you Canadians were smart, you'll start construction on your own wall to keep us out!!! Lol

[Bob Smith]

"If you Canadians were smart, you'll start construction on your own wall to keep us out!!! Lol"

Why, when one of your guys is offering to build it for us? We're going to make you pay for it. :)

[Tom Brown]

@Bob, touche'!

Nick, O/T: Cochrane brings up your balanced broom analogy (before dismissing it).

[Avon Barksdale]

"Avon: it would still be an equally difficult question, but it wouldn't matter as much if we got it wrong, percentage-wise."

Would it be an equally difficult question? Fewer special interests to satisfy, no grand vote buying exercises. Why is it such a difficult problem? We all chip in for truly public goods and then the government pays for those public goods. Seems pretty straightforward to me. It's only difficult problem if you view fiscal policy as a bunch of economic levers to pull.

[Henry Cunha]

"By making that partisan cheapshot, Paul Martin will make future fiscal policy worse."

I think it depends. Another party could do another round of real austerity (in good times) and then raise taxes and create new program spending (such as for childcare), and make the whole process politically acceptable. This may be Mulcair's long-term strategy. Harper's agenda is basically to constrain government, and it doesn't seem to matter if it's by tax reductions or by debt overhang. I think S. Gordon has this one right (http://www.macleans.ca/economy/economicanalysis/harpers-small-government-agenda-prevails-whether-he-wins-or-loses/).

"One maybe defence of the GST cuts: it's the provinces, not the feds, who have unsustainable fiscal policies, and you could maybe argue the provinces could and should have raised their own PST 1% or 2% to replace the federal GST cuts."

Ouch. There is nothing Harper would have relished more than the provinces raising their sales taxes after he lowered the feds' rate. What a political gift that would have been.

Considering the level of fiscal responsibilities of the provinces (like a 700,000-teacher payroll), perhaps there is something fundamentally wrong either with (1)Canadians' perceptions of the public services they want and the implicit costs, or (2)the overall tax level of the country, or (3)the division of the tax between jurisdictions, or (4) provincial and local government politicians are just reckless idiots.

[Internet Stranger]

Meh... I think the missing the point is...

Martin took all the the 'little' surpluses and put that aggregation of loot towards paying down debt; thus leaving his successors a great set of books to start from.

Harper then took all of the surpluses and turned them into tax cuts for the top dogs in homage to the failed fantasy of the Laffer curve.

While Martin may justifiably be accused of defending his legacy, he is correct - if hyperbolic - about Harper's economic fantasies.

[Best Beta Trading]

It is impossible to stay out of politics on this blog. Being macro, it is inherently fiscally RW and probably centered along the PC Party axis. This blog would've preferred to bail out all manufacturing in distress rather than auto makers, for example (I liked plant conversions to wind turbines).
I think the age of GDP is nearly dead. The externality accounting GDP (socially responsible, Green, etc), is a good start, but ignores many obviously externalities (King was friendly with Hitler).
It can be amended to encompass AI, pandemics, tyranny, mental health affecting/sensoring technologies...
The main problem I have for now is many of these are classified to various levels. Much of the content you wouldn't want to broadcast at all.
This new economics is a percentage of how optimal a given economy leads to a utopia. The percentages, which go down when politicians attack carbon pricing and up when they respond to meltdowns, can be translated into GDP growth and GDP.

[SvN]

Nick:

"Is there anything Stephen Harper could have done to have prevented a fiscal deficit over the recent recession?"

Aren't you missing an obvious options #3?

3. Run a large enough fiscal surplus prior to the recession that, even with the current mild/technical recession, there would be no deficit.

Now, if you want to continue to quibble about how fiscal policy should be adjusted quarter to quarter in light of new economic news, that's just fine. But wouldn't you agree that a more important question for economic welfare is whether a government has the discipline to maintain fiscal balance on average over the space of several years?

"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. " I agree.
But if we look at Canadian fiscal policy over the last 7 or so years, we see nothing but deficits. Do you think that is sensible? Do you think that is less important to the economy than what has happened with fiscal policy so far this year?

(Of course, we can also talk the political aspects of all this....but I thought I'd try to stick to the economics at first.)

[SvN]

"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. "

Actually, on the basis of the latest figures, isn't the budget currently "balanced"?