The Debt Monsters are Awakening … but Don’t be Afraid

For the first few months of the COVID-19 pandemic, traditional voices of fiscal austerity were largely silent – even as governments began to incur very large deficits in response to the pandemic. More recently, however, prominent advocates of balanced-budgets and debt reduction have renewed calls for spending restraint. In this commentary, originally published in the Toronto Star, Jim Stanford explains why current deficits are not so “spooky” – and why focusing on deficit-reduction would make the recession worse.

Trick-or-treating has been banned in several cities this Hallowe’en to limit the spread of COVID-19. But a rag-tag swarm of frightening creatures has nevertheless come out to frighten Canadians: with spooky stories about the risks of government deficits. Several of these bogeymen have even been spotted in the halls of Parliament.

During the first phase of the pandemic, as governments incurred unprecedented deficits, these debt monsters stayed in their caves. After all, the overwhelming consensus among economists and international financial institutions (like the IMF and the World Bank) is that governments must spend massively to fight both the pandemic and recession, and that trying to reduce deficits will do more harm than good.

But now the debt monsters have reawakened to scare us with warnings of profligacy and lurking catastrophe. Fiscal fear-mongering is coming from many of the usual suspects, like business lobby groups and conservative think tanks. But the most surprising (and spine-tingling) portent of doom was provided by Conservative finance critic Pierre Poilievre, who warned the Bank of Canada was becoming “an ATM for [Prime Minister] Trudeau’s insatiable spending.”

Mr. Poilievre was referring to the Bank’s purchases of federal bonds through quantitative easing – a practice that is common around the world, but which he called “insane.” His forthright attack on one of Canada’s most important institutions was extraordinary, and raises big questions about how Mr. Poilievre would relate to the Bank if he ever actually became Finance Minister. The scary rhetoric was rejected by most economists – but confirms that a major ideological battle over Canada’s post-COVID fiscal future has well and truly begun.

For several reasons, Canadians should laugh off these spooky tales about deficits lurking in our closets:

Interest rates are close to zero.

There is no cost to debt, if no interest is charged on it. And right now government debt is almost free: 0.5% for 10-year bonds. That’s below long-run inflation – which means we actually pay back less than we borrow.

The Bank of Canada is stabilizing debt markets.

By buying at least $5 billion in federal debt each week (and provincial government bonds, too), the Bank isn’t being anyone’s ATM. Rather, it is stabilizing debt markets, preventing financial panic, and suppressing interest rates. These actions are consistent with its mandate to reduce unemployment and boost inflation back to its 2% target.

Interest rates are a policy variable, which we can control.

The fiscal bogeymen warn that if interest rates escalate in future years, debt will quickly become unmanageable. But central banks control the direction of interest rate policies. Rates will only rise if central banks make them – and that would require much stronger economic conditions.

Debt does not have to be repaid.

Governments rarely “pay back” their debt: bonds are rolled over as they mature, and total nominal debt normally increases each year. (By the way, households and companies do the same thing in aggregate.) The huge debt we ran up during World War II (150% of GDP, three times today’s level) was never repaid. Instead, it receded in importance (to under 20% by the mid-1970s) as the economy grew around it.

Government’s debts are Canadians’ assets.

Debt critics forget a fundamental principle of accounting: every debit is also a credit. That’s especially obvious in the case of Ottawa’s COVID spending. Pricey programs like CERB and the wage subsidy transferred tens of billions directly to Canadian households and businesses, helping them survive the shutdowns. Mr. Poilievre and his supporters know it’s politically suicidal to oppose those programs (which kept millions of Canadians in their jobs and their homes). So instead they just attack the deficit in general, without ever saying what programs they would cut to reduce it. Restraining future government support programs, in the name of deficit reduction, would literally make Canadians poorer.

In reality, these tales of looming national bankruptcy are no more frightening than a schlocky old horror flick. The crucial responsibility of government right now is to protect public health, support household incomes, and kick-start reconstruction. Yes, that will require big deficits – now and for years to come. That’s not scary: it’s a sign government is doing what it’s supposed to.