Flaherty’s choice

NationalPost.com – FullComment
January 10, 2011.    Stephen Gordon

This year’s federal budget is going to be an interesting one. A two-year stimulus package was introduced in 2009, which meant that the 2010 budget didn’t have much to say. But now some decisions will have to be made. Should the government extend the fiscal stimulus? Follow the United Kingdom’s example and embark on an austerity program to get rid of the deficit? Do nothing?

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And here’s the graph for employment (both graphs are based on OECD data):

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Canada is the only G7 country to have recovered pre-recession levels of output and employment. The story in 2010Q2-2010Q3 isn’t one of Canada lagging behind so much as the other G7 countries catching up.

In the early days of 2009, the case for fiscal stimulus was fairly compelling: output and employment were falling sharply, and the Bank of Canada was about to hit the interest rate lower bound. Things are very much different now, and it’s hard to see how a convincing case for extended fiscal stimulus could be made using available data.

So should we embark on a round of austerity to deal with the deficit? Well, no: the recovery isn’t really complete. Yes, total employment has recovered its pre-recession peak, but important series such as full-time employment, private-sector employment and hours worked have not. (The hours worked series is choppy, so I’ve plotted the 3-month moving average.):

Read the rest of this post here < http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/01/the-federal-budget-austerity-vs-stimulus.html#more >

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In this post, I noted that Paul Martin didn’t bring down his famous 1995 austerity budget until after private-sector employment had recovered from its pre-recession peak. And in 1995, the Bank of Canada was in a position to offset fiscal austerity by cutting interest rates by 5 percentage points in the subsequent 18 months. Neither of these conditions are currently satisfied. The Bank of Canada may have created enough of a margin to handle small negative shocks, but not enough to counter a contractionary fiscal policy at the same time.

So that leaves neither renewed stimulus nor a program of austerity – at least, not for the 2011-12 fiscal year. Next year, if current trends continue, we’ll face a different set of circumstances: the recession will likely be behind us, and the deficit will likely still be with us. It would be nice to see some indication in this year’s budget of how the government intends to deal with next year’s problems.

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National Post

Stephen Gordon is a professor of economics at l’Université Laval in Quebec City, Canada and a fellow of the Centre interuniversitaire sur le risque, les politiques économiques et l’emploi. He is co-author of the blog site, Worthwhile Canadian Initiative.

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