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Budget puts Ottawa 'in difficult position' in event of economic slowdown

There's no longer a timeline for a return to a balanced budget with the net new spending

Deputy Prime Minister and Minister of Finance Chrystia Freeland delivers the federal budget in the House of Commons on Parliament Hill in Ottawa, Tuesday, March 28, 2023. THE CANADIAN PRESS/Sean Kilpatrick
While economists say Ottawa's 2023 budget will not significantly exacerbate inflation in the near term, the spend-heavy plan may put the federal government "in a difficult position" in the event of an economic downturn. (THE CANADIAN PRESS/Sean Kilpatrick) (The Canadian Press)

While economists say Ottawa's 2023 budget will not significantly exacerbate inflation in the near term, the spend-heavy plan may put the federal government "in a difficult position" in the event of an economic downturn.

Despite calls for fiscal restraint, the 2023 budget presented on Tuesday features larger deficits and elevated spending. The deficit for 2022-2023 fiscal year is an estimated $43 billion, less than the previously projected deficit of $53 billion. However, there is no longer a timeline for a return to a balanced budget. Ottawa had previously forecast that it would return to balance in 2027-2028, but now it is predicting a deficit of $14 billion.

The larger deficits are a result of higher spending, with net new spending up by $46 billion over six years.

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"An economy with excess demand, record low unemployment, and high inflation calls for more neutral fiscal policy," RBC economists Cynthia Leach and Josh Nye wrote in a note.

"With spending failing to right-size following the pandemic — program spending as a share of GDP is still significantly higher than before the pandemic — the government has left itself in a difficult position as it heads into an economic slowdown."

Earlier this month, the Bank of Canada became the first major central bank to pause interest rate hikes following eight consecutive increases in an effort to tame soaring inflation. The economy has already slowed in the wake of rising interest rates, with the economy showing no growth in the fourth quarter (real GDP was 0 per cent) following five consecutive quarterly increases. The government budget for 2023 is based on the assumption that GDP growth will be 0.3 per cent.

Desjardins chief economist Jimmy Jean and senior director of Canadian economics Randall Bartlett say while the economic outlook was more conservative, "the risks remain to the downside."

"Taken together, larger deficits and higher debt levels than projected in Budget 2023 are more likely than not. And that's without assuming any new spending going forward," Jean and Bartlett wrote in a research note.

"As such, the federal government would be wise to prepare for the worst instead of hoping for the best."

Still, the billions in spending will not likely contribute to inflation in the near term. Former Bank of Canada governor Stephen Poloz wrote in a post-budget report for Osler, Hoskin and Harcourt LLP that "it will be much harder to argue now that fiscal policy is still contributing to above-normal inflation and interest rates." Finance Minister Chrystia Freeland has repeatedly promised that Tuesday's budget would be fiscally restrained in light of a slowing economy that could weigh on government coffers.

"Arguably, that horse has already left the barn," Poloz wrote of the government's desire not to add further inflation pressures in the economy.

"If the government had reduced its fiscal stimulus a year ago, it would have meant fewer inflation pressures and a lower profile for Bank of Canada interest rates, and therefore less collateral damage to the economy — a missed opportunity to benefit many Canadians."

In fact, Poloz says a budget focused on investments that expand economic capacity – he cited the childcare program and completion of the TransMountain pipeline as two examples – could serve as disinflationary policy.

"Given that the demand side of the economy is already slowing sharply and most of the effects of last year's increases in interest rates have yet to appear, it is even possible that Budget 2023 will help improve the odds of a soft landing in the economy, by buffering demand and boosting supply," he said.

"Given the complexity of the situation and the uncertainty around the outlook, it is simply too close to call."

With files from The Canadian Press

Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.

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