A new report from the Fraser Institute examined whether the federal government’s current fiscal policies adhere to the target to reduce the debt ratio over the next 25 years.
According to the study, “the current federal fiscal policy is at odds with the Bank of Canada’s monetary policy.”
“Financing increased spending by running deficits boosts aggregate demand, which means that the Bank of Canada has to maintain interest rates higher for longer to bring inflation back to the 2% to 3% target range.”
The Trudeau government postponed reducing its deficit following the pandemic and has since increased spending dramatically.
“Our simulations indicate that there is a high probability of an increasing debt ratio in the future because of the impact of recessions on federal finances. It is, therefore, worthwhile examining in more detail the impact of recessions on the federal debt ratio,” reads the study.
The research group used a Monte Carlo simulation model, which is a computer algorithm that relies on repeated random sampling to obtain numerical results.
They added random shocks to the economy’s growth rate, which were similar to what Canada’s economy has experienced over the past 40 years.
The results were an increased likelihood of higher debt ratios in the future, including higher interest rates.
Fraser’s model indicates that Canada’s net debt ratio has a 44% chance of being higher in 2036/37 and even higher still in 2046/47 with an increased likelihood of 59%.
The projections come at a time when the average Canadian is already suffering from the highest disposable income to debt ratio since 1990, according to data from Statistics Canada.
The proportion of disposable income going to debt payments increased by 15.22% in the third quarter of 2023, up from 15.08% in the second quarter of last year.
Also the average Canadian household is now spending about 15 cents of every dollar (after tax) to service their debt. That’s 5 cents more than the average household in the U.S., which is paying a debt ratio of 10%.
“The continued postponement of deficit reductions by the federal government has raised the likelihood of higher future debt ratios in the event of economic downturns,” the study continued.
“To mitigate this risk, increasing the primary budget balances through reduced program spending as a percentage of GDP is crucial. This strategy will enable the federal government to finance larger deficits from recessionary shocks without triggering an unsustainable increase in the debt,” the study concluded.
