Fiscal PolicyFiscal PolicyDuring and After the Crisis

Tiff Macklem

Associate Deputy Minister G-7 Deputy for Canada

Finance Canada

Outline of TalkOutline of Talk

• Role of fiscal policy in stabilizing the economy• Role of fiscal policy in stabilizing the economy

• Impact of stimulus in Canada

• Aftermath – need for consolidation

• Canadian experience of mid-1990s

• Canada’s exit strategyCanada s exit strategy

2

Role of Fiscal Policy in Stabilizing the Economy

3

In addition to automatic stabilizers, large discretionary stimulus measures were implemented in response to the largest global recession since the 1930s

In addition to automatic stabilizers, large discretionary stimulus measures were implemented in response to the largest global recession since the 1930s the largest global recession since the 1930s the largest global recession since the 1930s

Discretionary Measures in 2009 and 2010, G7 countries

P t f GDPPer cent of GDP

5.0

3.0

4.0

1 0

2.0

0.0

1.0

Canada Japan USA Germany UK France Italy

44

Sources: IMF, The State of Public Finances Cross-country Fiscal Monitor, November 2009.

IMF estimates exclude loans, including those to the auto sector, for all countries. Figure for Canada includes provincial-territorial stimulus in addition to that assumed in the Economic Action Plan as estimated by the Department of Finance Canada.

The effectiveness of fiscal policy in stabilizing the economy depends on several factorsThe effectiveness of fiscal policy in stabilizing the economy depends on several factorsy py p

Response of monetary authorityResponse of monetary authority

• Accommodation

• Zero bound constraint• Zero-bound constraint

Degree of leakage (imports and savings)

Degree to which consumers are forward looking

Perceived fiscal position (sustainability)Perceived fiscal position (sustainability)

Speed of implementation

5

Canada’s stimulus plan is “well-diversified and structured for maximum effectiveness” IMF, May 2009Canada’s stimulus plan is “well-diversified and structured for maximum effectiveness” IMF, May 2009

13% 15%

yy

9%

EmploymentInsurance and

Training

Reducing the Tax Burden

Support for

Support for

Infrastructure and Housing

R&D

33%

Support for Industries and Communities

30%

A dditi l $200 billi t i t fi iAn additional $200 billion to improve access to financing Note: Figures do not include provincial, territorial or municipal leverage. Measures to support research and development include infrastructure improvements to colleges and universities. Measures to support industries and communities include targeted reductions to corporate income tax announced as part of the Economic Action Plan in Budget 2009.Source: Budget 2010 – Canada’s Economic Action Plan, Year 2

Prudent fiscal multipliers were used in assessing the impact of the stimulusPrudent fiscal multipliers were used in assessing the impact of the stimuluspp

Dollar impact (after 8 quarters) on the level of real GDP of a one-dollar increase in fiscal measuresone-dollar increase in fiscal measures

1 6

2.0

1.2

1.6

0.4

0.8

0.0

Infrastructure/housing Measures for low-income households and

Personal income tax

7

investmentincome households and the unemployed

measures

Design and situation suggest high effectivenessDesign and situation suggest high effectivenessg gg gg gg g

The sustainable fiscal situation the• The sustainable fiscal situation, the composition of the stimulus and its rapid implementation contributed to its effectiveness

• Widespread global actions limited import leakages

• Fiscal policy should have led to crowding-in effects with the policy interest rate essentially at zero and with forward-looking agents

• See NBER Working Paper “When is the Government S di M lti li L ?” b Ch i ti Ei h b

8

Spending Multiplier Large?” by Christiano, Eichenbaum and Rebelo, October, 2009

Impacts of Fiscal Stimulus in Canada

9

Areas targeted by the Economic Action Plan rebounded strongly following its implementationAreas targeted by the Economic Action Plan rebounded strongly following its implementationg y g pg y g p

Real Final Domestic DemandGrowth

Real Government Fixed Capital Formation Growth

4

6per cent, period to period at annual ratesper cent, period to period at annual rates

25

30

0

2

15

20

25

Average since 2000

-6

-4

-2

5

10

-82008Q3

2008Q4

2009Q1

2009Q2

2009Q3

2009Q4

02008Q3

2008Q4

2009Q1

2009Q2

2009Q3

2009Q4

10

Source: Statistics Canada.Source: Statistics Canada.

Consumer and business confidence improved markedlyConsumer and business confidence improved markedlyp yp y

Consumer Confidence Business Confidence

100105110index, 2002 = 100

105

110index, 2002 = 100

80859095

100

85

90

95

100

60657075

Historical Average

70

75

80

85

Historical Average

5055

Jan2005

Jan2006

Jan2007

Jan2008

Jan2009

Jan2010

65

70

2005Q1

2006Q1

2007Q1

2008Q1

2009Q1

2010Q1

11

Source: The Conference Board of Canada. Source: The Conference Board of Canada.

Model-based estimates suggest that the Action Plan has had a significant impact on growth …Model-based estimates suggest that the Action Plan has had a significant impact on growth …g p gg p g

Real GDP Growth and the Economic Action Plan

4

6Actual Real GDP Growth

per cent, period to period at annual rates

0

2

4Real GDP Growth without EAP

-4

-2

-8

-6

2008 2008 2009 2009 2009 2009

12

Q3 Q4 Q1 Q2 Q3 Q4

Source: Budget 2010.

… and employment… and employmentp yp y

Employment Growth and the Economic Action Plan

2

per cent, period to period at annual rates

2

0

-4

-2

Actual Employment Growth

-62008 2008 2009 2009 2009 2009

Employment Growth without EAP

13

Q3 Q4 Q1 Q2 Q3 Q4

Source: Budget 2010.

Private demand has rebounded in Canada but remains fragile in most other G7 countriesPrivate demand has rebounded in Canada but remains fragile in most other G7 countries

Evolution of Real Private Final Domestic Demand1

Index, 2009Q1 = 100

gg

102

103

US JAP UK GER

FRA ITA* CAN

100

101

98

99

97

98

09Q1 09Q2 09Q3 09Q4 10Q11

14

1 Private consumption expenditures and private fixed investment.

* Italy does not publish separate estimates for private and public fixed investment. As a result, Italy’s private final domestic demand includes government fixed investment.

Sources: Statistics Canada; U.S. Bureau of Economic Analysis; Cabinet Office; Office for National Statistics; Deutsche Bundesbank; Institut National de la Statistique et des Études Economiques; Istituto Nazionale di Statistica; Department of Finance calculations.

Aftermath:te atThe Need for Fiscal

C lid iConsolidation

15

Stimulus was appropriate and necessary, but there has been a rapid deterioration in the fiscal situationStimulus was appropriate and necessary, but there has been a rapid deterioration in the fiscal situation

Total Government Net Debt, G7 Countries

pp

140

1602007 2010 2014

per cent of GDP

80

100

120

40

60

80

0

20

Canada Germany France United States United Kingdom Italy Japan

16

Source: IMF, World Economic Outlook (October 2009).

Gross debt in the G-7 now as high as in the early 1950sGross debt in the G-7 now as high as in the early 1950s

G-7 Gross Government Debt, PPP weighted

100

120per cent of GDP

60

80

20

40

0

20

1950 1960 1970 1980 1990 2000 2010

17

Source: IMF Calculations

Sharp rise in public debt is exposing governments with weakest fiscal positions to rapidly rising risk premiaSharp rise in public debt is exposing governments with weakest fiscal positions to rapidly rising risk premia

10-Year Spreads to Germanybasis points

General Government Gross Financial Liabilities

Per cent of GDP

p p y g pp p y g p

140

160

basis pointsPer cent of GDP

600

700

PortugalItaly

80

100

120

400

500IrelandGreeceSpain

40

60

80

PortugalItalyIreland

200

300

0

20

1995 1998 2001 2004 2007 2010

IrelandGreeceSpain

0

100

Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10

18

Source: OECD

Most countries facing additional pressure from population agingMost countries facing additional pressure from population agingp p g gp p g g

Elderly (age 65+) as a Proportion of the 15-64 Population: Expected Changes from 2010 to 2030

25

percentage points

p g

15

20

5

10

0

5

Europe China Italy U.S. France Canada Germany Japan

19

Source: United Nations World Population Prospects 2008

Canadian Consolidation Experience of the mid-1990s

20

Debt burden rose steadily for more than two decades Debt burden rose steadily for more than two decades

Net Debtper cent of GDP

yy

100

120

Federal Provincial/Territorial

60

80

20

40

01970-71 1973-74 1976-77 1979-80 1982-83 1985-86 1988–89 1991–92 1994–95

21

Source: Canada and Provincial Public Accounts

Growing sense of crisis by mid-1990s provided the impetus for significant actionGrowing sense of crisis by mid-1990s provided the impetus for significant actionp gp g

1994 Mexican peso crisisRapid depreciation of the Canadian dollar- Rapid depreciation of the Canadian dollar

- Demonstrated the vulnerability of high-debt nations to international financial markets

WSJ Editorial: “Bankrupt Canada?” (January, p ( y1995)

- “Honorary member of the third world”- “Canada could hit the debt wall and have to call the

IMF”

22

The policy actions were very difficult and painful, but led to the elimination of a large deficit in just four years

The policy actions were very difficult and painful, but led to the elimination of a large deficit in just four yearsyearsyears

Total GovernmentProgram Spending

Total GovernmentFiscal Balance

6

8Budgetary Balance

Primary Balance40

42

per cent of GDP

Peak to trough:Total government program spending

per cent of GDP

2

0

2

4y

38

40 program spending -9.6 p.p. of GDP

8

-6

-4

-2

34

36

Peak to trough:Total government

-12

-10

-8

1980 1984 1988 1992 1996 2000 2004 200830

32

1980 1984 1988 1992 1996 2000 2004 2008

budgetary balance +12.0 p.p. of GDP

23

Source: Statistics Canada.

Major 1998 reform to CPP/QPP also put the systems on a sustainable path over the long runMajor 1998 reform to CPP/QPP also put the systems on a sustainable path over the long runp gp g

CPP and QPP Contributions and Benefits

4

12

14Cumulative Balance (right)Contributions

per cent of GDP

1998 Reform raised contribution

Actuarial forecasts

per cent of GDP

3

8

10

12Benefits rates by 70%

2

4

6

8

0

1

0

2

24

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019

Sources: Statistics Canada, OSFI Actuarial Report on Canada Pension Plan (2009); L'analyse actuarielle du Régime de rentes du Québec (2007).

Large fiscal consolidation lowered growth temporarily in 1996, but growth bounced back as credibility and confidence built upLarge fiscal consolidation lowered growth temporarily in 1996, but growth bounced back as credibility and confidence built upg y pg y p

Real GDP Growth in Canada and the United Statesper cent

4

5Canada

U.S.

per cent

3

4

1

2

0

1

1993 1994 1995 1996 1997 1998

25

Source: Statistics Canada, U.S. Bureau of Economic Analysis.

Lower debt service costs led to significant debt and tax reductionsLower debt service costs led to significant debt and tax reductions

Total Goverment Net Debt and Revenues

90%

100% 46%Per cent of GDP

70%

80%

90%

42%

44%

50%

60%

40%

42%

20%

30%

40%38%

Net Debt (left axis)

0%

10%

20%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 200834%

36%( )

Revenues (right axis)

26

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Source: National Balance Sheet – Book Value

Lessons Learned from Canada’s Fiscal Consolidation of the mid-1990sLessons Learned from Canada’s Fiscal Consolidation of the mid-1990s

1. Credible plans must be developed and communicated early– Measures well identified– Prudent economic assumptions– Under-promise/over-achievep

2. Initiate consolidation as soon as possible - don’t be too gradual and allow monetary policy to play its macrostabilization role

3. Focus on spending reductions and measures that will increase potential growthincrease potential growth

Wh t d thi f th t it ti ?

27

What does this mean for the current situation?

Canada’s Exit StrategyCanada s Exit Strategy

28

Budget 2009 implemented temporary stimulus and early actions to secure sound long-run fiscal positionBudget 2009 implemented temporary stimulus and early actions to secure sound long-run fiscal position

Temporary Action Plan stimulus, concentrated in

y g py g p

2009 and 2010

P t ti t i t i d t t lPermanent actions to maintain sound structural finances:

• Reforms to Equalization to ensure sustainability• Reforms to Equalization to ensure sustainability• Better managed federal compensation regime• Reviews of departmental spending andReviews of departmental spending and

corporate assets

29

Budget 2010 builds on Budget 2009 early actions by setting out a 3-point plan to return to budget balanceBudget 2010 builds on Budget 2009 early actions by setting out a 3-point plan to return to budget balance

• Follow through on the “exit” strategy in the

g p p gg p p g

• Follow through on the exit strategy in the Economic Action Plan by ensuring that temporary stimulus is wound down by the

d f thi fi lend of this fiscal year

• Targeted measures to restrain direct program di th th t b ild th dispending growth that build over the medium

term

C h i i f• Comprehensive review of government administrative functions and overhead costs

30

Budget 2010 track to return to balance Budget 2010 track to return to balance gg

Projected Federal Budgetary Deficit

billions of dollars

60Withdrawal of stimulus reduces deficit by half Impact of Budget 2010 Measures

40

50y

20

30

0

10

2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15

31

Source: Budget 2010.

ConclusionConclusion

Fi l li h diff t i t i l dFiscal policy has very different impacts in normal and exceptional economic circumstances

Di ti ti l ti t kDiscretionary stimulus actions taken were necessary, appropriate and worked

C lid ti i ft th f i i i t tConsolidating in aftermath of crisis as important as stimulus actions

Markets already demanding commitment to reducedMarkets already demanding commitment to reduced public debt and improve fiscal sustainability

Lessons from Canadian experience

32

Lessons from Canadian experience

Fiscal PolicyFiscal PolicyDuring and After the Crisis

Tiff Macklem

Associate Deputy Minister G-7 Deputy for Canada

Finance Canada