Stephen Harper and Economics 101

Prime Minister Stephen Harper, who prides himself on being an economist, has characterized his government’s fiscal policy as “expansionary.”

If he really thinks the simple fact of running a budget deficit is “expansionary”, he should repeat Economics 101.

The correct way to look at the question of whether fiscal policy is expansionary or contractionary is not to look at the budget balance in isolation, but to look at the year to year change in the cyclically adjusted budget balance as a share of GDP – ie the change in the budget balance (surplus or deficit) which can be attributed to discretionary actions on the spending and tax side rather than to changes in the underlying economy.  Economists also look at the cyclically adjusted primary balance – which excludes changes in debt servicing costs – and at the cyclically adjusted budget balance as a share of potential GDP.

Estimates of these balances looking backwards are published in the Department of Finance Fiscal Monitor. Unfortunately, to my knowledge, the Government of Canada does not provide estimates for the current year, or projections.  However, the IMF currently estimate that the total Canadian structural budget balance will fall by more than $14 Billion or by 1% of  GDP in 2011 compared to 2010. This is the result of both federal and provincial actions

The 2011 federal Budget projections (Table 5.7) show that the federal budgetary balance will narrow by 0.3% of GDP this year (from -2.2% to -1.9%) compared to last. While this is partly driven by a very modest cyclical recovery in tax revenues, the main factor is a fall in federal program spending of 0.3% of GDP, from 14.8% of GDP to 14.5% of GDP. The Budget itself (p.195) states that “the expiration of stimulus measures and the savings measures announced in the budget are expected to lower the ratio of program spending to GDP from 16.0% in 2009-10 to 12.9% in 2015-16.

In short, the federal government is deliberately cutting spending which will lower GDP. While there is still a small deficit, fiscal policy cannot be described as “expansionary.”