Budget needs to reflect volatility

Finance Minister Joe Oliver should take a second look at plans for Budget 2015 and promises for an election year array of goodies, particularly if the world drifts into permanent slow growth or faces growing risks of deflation.

Finance Minister Joe Oliver should take a second look at plans for Budget 2015 and promises for an election year array of goodies, particularly if the world drifts into permanent slow growth or faces growing risks of deflation.

The sharp drop in oil prices and volatility in stock and bond markets are danger signs that something is not right with the global economy.

As the International Monetary Fund’s managing director, Christine Lagarde, has put it, the world is stuck in “a brittle, mediocre recovery,” with global growth forecasts lowered once again. Fears over the Ebola pandemic and continuing instability in North Africa and the Middle East are adding to uncertainty.

For Canada, this translates into weaker prospects for jobs and economic growth.

Ottawa has been counting on a sharp pickup in exports and increased business investment to drive the next round of economic growth, as the housing market and the growth in consumer debt level off. But if that pickup does not occur — and monetary policy has largely done all it can for growth — then we will be in serious trouble.

To be sure, the fall in world oil prices is an overall benefit to the global economy — worth about US$600 a year to an average American household and also important for oil importing economies such as Japan, South Korea, Taiwan and China, similar to a tax cut.

The decline in the Canadian dollar exchange rate as oil prices tumble could make our manufacturing more competitive. But weak investment in recent years may also mean our manufacturers are not in a strong position to take advantage of a somewhat stronger U.S. market.

The sharp fall in stock market prices and slowdown in the housing market will also have what is known as a wealth effect. Consumers will feel poorer and hence more reluctant to spend or take on new debt. And if they are not confident about the future, businesses will be reluctant to invest. That too could slow economic growth.

The federal government’s tightened fiscal policy in recent years has been a drag on the economy, making a weak recovery weaker. And its excessive reliance on cheap money through the Bank of Canada’s monetary policy to boost growth through housing and other forms of consumer debt, while keeping growth alive, has also created what we now see to be a false sense of security.

One impact of monetary policy, with ultra-low interest rates, has been to help drive up the value of housing, stock market and other asset prices, which have soared in value. Now we are beginning to see what might be called a correction.

Some experts have argued that the Conservative government withdrew its Great Recession economic stimulus too soon and too fast, hurting the economy’s prospects.

Rather than aiming to balance the budget this coming year, a more responsible fiscal policy would have delayed balancing the budget by investing more in public infrastructure, where there is great need, helping the transition to a low-carbon economy, focusing on innovation, and doing more to reduce poverty in Canada.

These, rather than tax cuts, should be the main goals in the next federal budget. They would do much more to raise confidence in the future growth potential. To the extent that there are tax benefits, they should be focused on lower-income Canadians.

In the view of the chair of the IMF’s policy steering body, the International Monetary and Financial Committee, “we are only halfway through this journey of recovering from the crisis.” Tharman Shanmugaratnam, who is also Singapore’s finance minister, contends that “our real problem today is a lack of confidence in the medium to long term. This lack of confidence inhibits today’s activity and today’s growth.”

In other words, to achieve stronger growth and job creation today we have to make consumers and businesses more confident about the future.

“To solve today’s growth problems we have to lift potential growth, and that means reforms that don’t pay off immediately, but reforms that build confidence over the medium to longer term path,” Tharman says.

The Bank of Canada has lowered our potential growth rate several times over the past decade.

Tax cuts are likely to do little to raise our potential growth rate. But investing in skills, infrastructure, innovation and the low-carbon economy would likely do much more. This is why Oliver should think hard about what is best for Canada in Budget 2015.

Economist David Crane is a syndicated Toronto Star columnist. He can be reached at crane@interlog.com.

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