Canada can't spend its way out of recession, says Fraser report

Trying to kickstart the Canadian economy into recovery from the COVID-19 recession
through federal and provincial stimulus spending will fail, warns a new report by the Fraser
Institute.

The result will be weak economic growth,

rising unemployment levels and substantial
increases in already soaring government
deficits and debt, thus prolonging the
recession, according to the study by the
fiscally-conservative think tank, Is Fiscal
Stimulus an Effective Policy Response to a
Recession?

Study authors Jake Fuss and Tegan Hill say

economic research in both Canada and the
U.S. indicates stimulus programs to recover
from recessions built around such initiatives as
subsidizing the construction of new
infrastructure projects generate less than $1 of new economic growth for every $1 spent by
governments.

By contrast, giving broad-based, long-term tax relief to individuals and businesses generates
up to $5 of economic growth for every $1 spent.

“In the coming months, as governments contemplate trying to kickstart the economy with
more spending, they should recognize that evidence indicates (stimulus spending) is
ineffective and results in more government debt,” said Fuss, potentially making things even
worse.

The Fraser Institute study does not classify the $169 billion the Trudeau government is
spending on programs like the Canada Emergency Response Benefit, which provides $2,000
a month in income support to people who have lost their employment because of COVID-19,
as stimulus spending.

“The federal government’s spending up to this point is largely an emergency response to

COVID-19, including income stabilization measures, in an effort to help Canadians who lost
jobs or work hours due to the lockdown,” said Hill.

The Fraser Institute’s concern, she said, is that as federal and provincial governments shift
their focus from emergency funding to economic recovery, they will turn to inefficient and
costly stimulus initiatives.

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InThinking www.thinkib.net/Economics 1
“Before implementing any fiscal stimulus package,” Hill said, “policy-makers must consider
the potential implications on both the economy and government balance sheets, particularly
as governments across Canada face large deficits and mounting debt.”

The Fraser Institute study concludes the best way to speed up Canada’s economic recovery
coming out of the COVID-19 recession is through deficit-financed, broad-based tax cuts, paid
for by reducing government spending over the long term, as opposed to deficit-financed
stimulus programs, paid for by increased government spending and higher taxation over the
long term. The institute also states that where increased government is necessary is in supply
side policies, leading to ‘increased productivity and increased investment in research and
development'.

“Past history suggests that stimulus (spending) will not improve the Canadian economy and
may even be a detriment to it,” the study concludes, while “fiscal stimulus based on tax cuts
is ‘much more likely’ to be growth enhancing.”

Parliamentary budget officer Yves Giroux predicted last week the federal deficit this year
will hit $256 billion and the worst decline in economic growth since the 1981-1982 recession.

On Wednesday, Fitch Ratings, one of the three major U.S. credit agencies — the others are
Moody’s and S&P Global — downgraded Canada’s credit rating from AAA to AA+ because
of the amount of new debt the government has taken on to fight the COVID-19 recession.

The rating agency said it still considers Canada’s long-term economic outlook to be “stable.”

Prime Minister Justin Trudeau has promised to give Parliament and Canadians an economic
“snapshot” of the country on July 8.

But he has added it won’t be a full budget, or even an economic statement, because there is
still too much global uncertainty about the long-term global financial impact of COVID-19.

Original article accessed from the Toronto Sun on 29th December 2020.

Macroeconomic data for Canada (table 1)

GDP $ Unemployment Current Fiscal

Inflation %
billion % account $B balance $B
2019 1,763.4 5.5 2.2 -9,697 -19.8
2020
1,558 8.5 0.9 -7,528 -256.0
(estimate)

© Mark Johnson,
InThinking www.thinkib.net/Economics 2
Questions

(a) Define the following words from the passage:

i. Recession (line 1) [2 marks]

ii. Unemployment (line 4) [2 marks]

(b) i. Calculate the % fall in GDP and the rate of change in unemployment for Canada in
2020. [3 marks]

ii. The growth of which type of unemployment is likely to be represented by the rise in the
nation's unemployment rate from 5.5 to 8.5%. [2 marks]

(c) Explain using an appropriate diagram why the covid-19 pandemic will have caused the
Canadian economy to fall into recession. [4 marks]

(d) Provide two reasons why the government deficit might have risen to $256 billion as a
result of the economic problems facing the country? [4 marks]

(e) Explain using an AD / AS curve the likely impact of stimulus policies designed to recover
from recessions 'built around such initiatives as subsidizing the construction of new
infrastructure projects.’ (line 10) [4 marks]

(f) Illustrate using an AD / AS curve the impact of ‘supply side policies’, leading to
‘increased productivity and increased investment in research and development’. (Line 35-
36) [4 marks]

(g) Using extracts from the passage as well as your knowledge of economics, evaluate
the view that the Canadian government cannot spend their way towards economic
recovery. [15 marks]

© Mark Johnson,
InThinking www.thinkib.net/Economics 3