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Balanced Budget Law is Poor Economics


The balanced budget legislation introduced as part of the federal budget is based on dubious economic principles that should raise the eyebrows of even fiscally conservative economists.

Bill C-59 requires the federal government to balance the budget and to reduce debt each and every year except when there is a recession or emergency, and imposes significant sanctions on ministers and deputy ministers if this is not the case. The preamble to the bill states that a balanced budget is crucial to economic growth and job creation over the longer term.

Times of recession and emergency are fortunately the exception rather than the rule, so balanced budgets would be the norm moving forward. Under such a scenario, the federal public debt would shrink rapidly as a share of the economy from an already very low level compared to other advanced economies.

The International Monetary Fund and Parliamentary Budget Officer argue that it makes more sense to stabilize debt as a share of the economy than to reduce it every year outside emergencies. Very few economists argue that the debt should be zero.

Federal government bonds are an important asset for savers, particularly institutional investors. Pension funds in particular need low risk, long term government bonds to safely match long term assets and liabilities.

Federal bonds are an important asset for the financial system as a whole since they are almost completely risk free. The government will never default so long as the Bank of Canada is there to backstop the market.

While the federal debt will never be allowed to fall to zero, problems may emerge in the bond market as the outstanding debt shrinks well below the current debt reduction target. A healthy bond market requires some minimum level of volume and new bond issues to satisfy demand and maintain liquidity.

There is a close link between the government bond market and the conduct of monetary policy, particularly when it comes to influencing longer term interest rates. While the Bank of Canada has not engaged in so-called quantitative easing, other central banks including the US Federal Reserve and the European Central Bank have intervened in the secondary market for public debt to speed economic recovery.

Further, economists draw a distinction between government borrowing to finance current spending on programs and services, which should normally be balanced by revenues, and borrowing on the capital account to finance investment in long term assets which should be amortized over many years.

The federal government can still amortize some investments over the life of an asset, such as a federal bridge, but it must account immediately for the full cost of a transfer to the cities or provinces to build needed public infrastructure.

Given a very large infrastructure deficit, the known benefits to the private sector of infrastructure investment and very low interest rates, we should not let a balanced budget law will get in the way of significantly increasing federal capital investments.

The requirement to always balance the budget outside recessions is also foolish when it comes to the pursuit of short-term macro-economic policy. There are three major sectors of the economy – corporations, households and governments – and all three cannot be saving at the same time unless we want to be net lenders to the rest of the world.

Given that Canadian corporations are large net savers today and that households are already holding very high levels of debt, a series of budget surpluses is likely to condemn us to very slow growth and job creation. The IMF and many others have argued that a balanced budget is not optimal until business investment starts to rise and begins to make a significant claim on savings.

Balanced budgets sound appealing to many voters, but legislation to balance the books each and every year is poor economics.

Andrew Jackson is Adjunct Research Professor in the Institute of Political Economy at Carleton University, and senior policy adviser to the Broadbent Institute. This article originally appeared at the Globe and Mail's Economy Lab.

Photo: debord. Used under a Creative Commons License.