Finance Committee on Oct. 31st, 2017

[Chris Matier]

I think part of that reaction stems from the linkage between a household's budget constraint and the government's budget constraint. Really there isn't a linkage. Unlike households, the government doesn't have to repay ultimately its debt. The way I try to think about it or would explain it is that what you really want to think about is the debt burden. For the debt burden, the most commonly used measure is the debt relative to the economy.

What typically governments wouldn't necessarily want to do is to undertake fiscal policies such that this burden would be substantially increased for future generations. You can think of the idea of keeping a stable debt-to-GDP ratio as basically not passing on an increased debt burden. It's important to think about it in a ratio, because the incomes of future generations will be a lot higher than they are today. Their ability to service debt should be commensurate to what the burden is based on current taxpayers.

Maybe unfortunately, some economists have linked the balanced budget or debt elimination as the best indicator of sound financial management, when I think a much better one, and one that is most commonly used by budget offices and I would say most economists, is the debt-to-GDP ratio.

[Jennifer O'Connell, Liberal, Pickering—Uxbridge, ON]

Thank you.

[The Chair, Liberal, Wayne Easter]

Thank you, all.

I'll turn to Mr. Kelly.

[Pat Kelly, Conservative, Calgary Rocky Ridge, AB]

Thank you.

I do just also for the record, Mr. Chair, want to comment on what Mr. Grewal had said earlier. In commenting on the debt-to-GDP ratio being projected perhaps to drop to 29% versus 31%, he characterized that as a commitment that they had made. I want to remind the committee that the commitment that was made in the election campaign was not a 31% debt-to-GDP ratio. It was in fact to run a maximum $10-billion deficit with a return to surplus by 2019.

Having said that, I'll go to the questions and pick up perhaps on a theme arising from a response to the very first questions that my colleague, Mr. Sorbara, raised, and this was in regard to the negative impact on the housing market and on Canadian households when interest rates rise as they're expected to do.

We have heard throughout, in this panel and in the earlier one, about just how difficult it is to forecast the future and all of the different factors. We've heard repeatedly that there are an infinite number of variables and so it's very hard to know for certain what is ahead of us.

How much risk is there to projections of a reduced debt-to-GDP ratio and indeed to continue increased deficits that are ultimately, as my colleague, Mr. Poilievre, pointed out, borne by Canadian households through taxes? What are the risks of these projections not being made if, for example, there was even a slightly larger rise in interest rates than what you have already included in your projections?

[Chris Matier]

We've tried to quantify this risk in our last two reports. In figure 7, we provide an estimate of the probability that the debt-to-GDP ratio would be above its target in 2021, that 31% target. It would be about a 25% chance. That's based on the assumption that we're basically about as accurate going forward as, let's say, on average, private sector forecasters have been in the past.

If we miss on interest rates and growth rates, all else equal, no policy changes, this is what we would expect as that amount of risk.

[Pat Kelly, Conservative, Calgary Rocky Ridge, AB]

Any of a number of factors could throw this off including a failure to predict a significant downturn in the global economy, something that very few forecasters ever predict accurately.

[Chris Matier]

That's true and our estimate would reflect that. To the extent that in history we've missed those downturns, we've built that into our estimate of the probability going forward. If we continue to be as bad at forecasting as we were during the past, roughly 25% of the time we would still miss this debt-to-GDP target.

[Pat Kelly, Conservative, Calgary Rocky Ridge, AB]

I'm not sure how much reassurance that was intended to convey.

All this uncertainty is part of why many commentators and many people would say it is so unwise to run large deficits during non-recessionary times. If you're in an expanding economy and times are, relatively speaking, at least not recessionary, ought not the government run a balanced budget as promised or at least try to come as close as they can so that, if there is an unforseen downturn, there is fiscal capacity to deal with it?

[Chris Matier]

I'm not going to comment on what the government's fiscal target or policy should be with respect to having a balanced budget or not. That is a political choice.

Economically speaking, there is nothing requiring a government to run a balanced budget year after year or only in certain periods. In our longer-term framework what we've tried to stress is that, at least according to conventional economics, it's the debt-to-GDP ratio. Even with a relatively stable debt-to-GDP ratio, that would imply or be consistent with relatively small budgetary deficits, on balance, over the cycle.

In terms of the shock absorber, to respond to your question about what would happen in the event of a severe downside shock, that's simply the case where the government would have to go and borrow and absorb part of that shock. Again, if it's a very extreme financial market shock where the government couldn't go and issue debt, that's a very extreme scenario. In all other cases of relatively slower growth or weaker oil prices or something, that probably would be absorbed with just issuing more debt and running larger deficits temporarily.

[The Chair, Liberal, Wayne Easter]

Mr. Fergus.

[Greg Fergus, Liberal, Hull—Aylmer, QC]

Thank you, Mr. Chair.

Mr. Fréchette, my thanks to you and your team for your hard work. It is very much appreciated. I enjoyed the work of the Parliamentary Budget Officer before I became a member of Parliament and I appreciate it more as a member of Parliament.

I would like to come back to your report on the economic and fiscal outlook. I am referring to Figure 6. My colleague Mr. Dusseault talked a bit about it and I would like to ask you a few more questions.

With the 70% confidence interval—I know this is the least accurate interval—we can see the possibility of accumulating a deficit of about $30 billion or having a surplus budget just over $10 billion by the end of the 2021-22 fiscal year.

It may seem a bit crass to you, but can you explain how it is that your forecasts present us with both the worst and the most optimistic of situations?

[Chris Matier]

Unfortunately I don't have that with me, but I can follow up on what real GDP growth, nominal GDP growth, and interest rates would be.

Typically, in those outer years, you would see, in terms of nominal GDP, our 70% confidence interval is plus or minus a full percentage point, or 1.1 percentage points. On interest rates, I don't recall what the range would be, but at least in those intervals you would see low growth-high interest rates, high growth-low interest rates. I can follow up with the exact range for the interest rates.

[Greg Fergus, Liberal, Hull—Aylmer, QC]

Let me ask a more specific question.

You said that the Bank of Canada's key policy rate could eventually be at 3%, which is much higher than the current rate. Why do you think it is likely that the Bank of Canada's policy rate will be at that level? It has been a long time since it was at that level.

[Chris Matier]

The 3% level that we have assumed in our base case is consistent with the Bank of Canada's estimate of its policy rate when inflation is at its target, when the economy is at its potential capacity, and when there aren't any temporary shocks.

In putting this together, essentially we've looked at the Bank of Canada's monetary policy report and at current levels of interest rates. We know, according to the bank, that inflation will be at its target in, I think, the first half of 2018. The economy will essentially be at its productive capacity or potential output. I don't think the bank has flagged any temporary shocks, so, implicitly underlying the Bank of Canada's forecast, our conclusion is that interest rates are going back up to 3%. They're the ones who set the policy rate, and if their judgment is that 3% is the right number, we're going to take them at their word and that will be in our forecast.

Of course there will be shocks, going ahead. Some of our underlying assumptions won't pan out, and interest rates could be higher or lower than we're projecting on our way to 3%, or its neutral rate. It would obviously be helpful if the Bank of Canada were to publish its policy rate path, going forward, but you can read between the lines. It's clearly indicated in the report that 3% is what they believe is consistent when inflation is at its target and the economy is at its productive capacity or potential output.

[Greg Fergus, Liberal, Hull—Aylmer, QC]

Once again, I do not want to question the merits of the Bank of Canada's decisions. It's almost the end of the year. The policy rate has been low for nine years. During the crash of 2008, the rate was lowered at the outset and it has remained low for a significant period. Earlier this year, there were two small increases in the policy rate.

Now, we recognize that, given the debt of Canadians, the competition in the digital technology sector and the economic slack, the policy rate will continue to be low in the short term. It seems to me that it will take quite some inflation or quite some economic growth—which I would like to see— for the rate to reach 3%. Once again, we rely on the data provided to Canadians by the Bank of Canada, but does your instinct for economics not make you think about the possibility of a 3% policy rate?

[Chris Matier]

You're correct that we're going back to 3% as our estimate of the neutral rate. The one point I would make is that this estimate of the neutral rate has been revised downward significantly just over the period you mentioned, following the global financial crisis. I believe the Bank of Canada previously estimated that rate at around 4.75% and 4.5%, so there has already been a very large reduction. We're not going back to levels that we're used to seeing.

When you're at 1%, 3% does seem like a big increase, but in the Bank of Canada's framework, they see inflation coming back. They see the excess capacity of the economy tapering off, so those conditions are consistent with a 3% policy rate.

[The Chair, Liberal, Wayne Easter]

I have a couple of questions before I go to Mr. Dusseault, followed by Mr. Picard, and then back here.

In your EI section, table 7, next year you're anticipating that the benefits will go up by $1 billion. On what do you base that estimate?

[Trevor Shaw]

Our benefits projection is mostly a function of our forecasts for the rate of unemployment and eligibility. If program rules change so that unemployed persons are eligible for benefits where they might not have been in the past, it's going to increase the ratio of EI beneficiaries relative to the number of unemployed.

I'll also highlight that as part of budget 2017, and even in the interim, between budget 2017 and the last update, there were a number of temporary changes to the EI program that increased the ratio of beneficiaries to the unemployed. That helps explain some of the increase in our EI benefits forecast over the medium term.

[The Chair, Liberal, Wayne Easter]

With the premium rate at $1.88, or $1.63 now, how does that compare going back in time? It seems to me that it was considerably higher.

[Trevor Shaw]

Just off the top of my head, the EI premium rate was higher than $1.88 in the past. In previous years, it had been in excess of $2. I could get you the historical series.

[The Chair, Liberal, Wayne Easter]

We can probably find it anyway.

In your table 6, under children's benefits, does that include the economic update, the increase?

[Trevor Shaw]

Yes.

[The Chair, Liberal, Wayne Easter]

Okay. In table 5, where does the small business tax fit into your chart? Is it under the corporate income tax?

[Trevor Shaw]

Yes. It's corporate income tax.

[The Chair, Liberal, Wayne Easter]

Does that include the economic update going out?