This is the time to raise fiscal spending, not lower interest rates

Posted on February 15, 2015 in Debates – ROB/Commentary/ROB Insight
Feb. 13 2015.   David Rosenberg

The Canadian dollar is improving and ordinarily would be doing even better had the Bank of Canada not painted a bulls-eye on the forehead of the poor loonie.

I have to admit that I am a bit embarrassed that Canada would have been the country to have touched off this latest round of the global currency war with last month’s surprising (and unnecessary) rate cut – with a seeming pledge to do more.

The housing market is, according work published by the central bank, 35 per cent overvalued.

I can see cutting rates if home prices were undervalued, but shouldn’t the BoC be a little concerned that stimulating the most credit-sensitive sector like this is only going to add fuel to the fire?

After years of chatter from the central bank over excessive consumer indebtedness, it cuts rates – to applause from most economists – as if to say “please, take on more credit and overextend yourself even more.”

It is clear to even the most casual observer that this rate cut was more aimed at easing through the currency to artificially lend support to manufacturers as an antidote to the plunge in energy capex, as well as to help stabilize the Canadian-dollar price of oil for our Western producers.

There is no rate cut from a 1-per-cent level – at a time of peak housing activity and high debt ratio levels – that will provide a thrust to the credit-oriented sectors.

In the process, however, the Bank of Canada has really just made us poorer as we earn devalued loonies which buy us fewer goods and services, especially in the United Sates. If you’re an importer, sorry; but if you’re an exporter or tourist operator, welcome to the wonderful world of mercantilism.

Now in the euro area and Japan, until recently, they had a serious deflation threat so their dramatic policy easing was justified; Canada has core inflation of 2 per cent or higher.

Easing through the currency is just a “quick fix” and is a very blunt tool to use to offset the weakness in the energy patch, and the problem is that depreciations create winners and losers.

What Ottawa should have done, in my opinion, is to stop wearing fiscal balance or surpluses (when you count in the $3-billion “contingency” reserve) as some badge of courage, and start to fiscally reflate. The economic impact would be felt immediately and there are no losers.

The government could announce today a $25-billion “shovel ready” infrastructure program that would offset the capex plunge in the resource sector – and guess what? The federal debt-to-GDP ratio (32 per cent) would not budge one iota.

This would be a far more effective response and with a far more powerful multiplier impact.

If I really thought that currency devaluation was the answer to a private sector capex shortfall, I’d say so. But Ottawa would be better off filling the private sector capex hole with a public-sector capex program. There just has to be the political will.

When you have a government that has a Tea Party mentality when it comes to government spending, it’s obviously a difficult proposition.

That said, you do not have to be a Keynesian to realize that now is not the time to be focused on fiscal balance.

One more thing. It’s not that the Feds are simply running a prudent fiscal policy – they are running an unnecessarily tight fiscal policy.

Strip out interest charges, and Ottawa is running a primary surplus (the fiscal balance excluding interest costs) of nearly $30-billion or 1.2 per cent of GDP. So basically, at the current time, there is actually a $30-billion gap between revenues and program spending – and at just the wrong time both in economic and political terms.

Now is not the time to cheapen the currency for a quick-fix antidote that only affects the winners, with long and variable lags in any event – not to mention how the losers (consumers, in other words) are ultimately affected. Now is the time for a swift and decisive fiscal boost. If the government wasn’t spending years strengthening our nation’s balance sheet to use it as a weapon against downside economic risks, as is the case today, then what was the point of it all?

We stopped being a fiscal basket case nearly 15 years ago – we really have nothing to prove to the world any more when it comes to flashing our tight budget credentials.

David Rosenberg is chief economist and strategist at Gluskin Sheff & Associates Inc.

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