The government has been under pressure for some time to provide an economic and fiscal update.  Everyone was aware of the huge increase in spending that had been incurred to assist Canadians during the Covid-19 pandemic and the impact it would have on the deficit for this fiscal year. The Parliamentary Budget Office (PBO) had been releasing forecast updates of the deficit for 2020-21 on a regular basis.

The pressure was on the government to provide its own economic and fiscal update. The government rejected the presentation of a normal Update option, arguing that it was impossible to provide any useful Update at this time because there was simply too much uncertainty and this made economic forecasting completely unreliable.

Eventually in order to avoid a fiscal update with multiyear projections, the government agreed to provide a “Snapshot” of the economy and the deficit.  Mr. Morneau promised that the “government will provide a longer horizon in the fall of this year”. At that time, economic results for the second quarter will be available, along with preliminary results for the third quarter.
And so in the lexicon of “fiscal policy implementation” there are now “budgets”, “updates”, and “snapshots”.

A snapshot is defined in the Cambridge dictionary as: “A piece of information or short description that gives an understanding of a situation at a particular time”.

This is exactly what Finance Minister Morneau provided on Wednesday.  Based on private sector forecasts for 2020 and 2021’ he estimated a deficit of $343.2 billion (15.9% of GDP), debt of $1.1 trillion (49.1% of GDP), and program spending of $592.6 billion (27.5% of GDP).  It took 186 pages of information already available on the Finance website.
So what did this “snapshot” accomplish? The answer is absolutely nothing.

In fact it might have made things worse for both Canadians and the government. Canadians knew that the deficit was ballooning and the economy was in free-fall. They are worried about what this means for their future job prospects, for their sources of income, and for the government support programs they now depended on. The snapshot definitely did not reduce their worries. The government has confirmed their worst expectations and simply left them hanging about their futures.
And the situation is only going to get worse not better. The reality is that the “snapshot” deficit is probably higher than $343.2 billion.  The current forecast can be viewed as a “best case” scenario.

First, the deficit forecast in the snapshot assumes that there will be no second wave and that the existing support measures will not be extended. Both of these assumptions are highly unlikely.

Second, the economic forecast for 2020 is clearly on the optimistic side. As in the past, the Minister of Finance has used the average of the economic forecasts from thirteen private sector forecasters. For 2020, real output is expected to decline by 6.8%. However, underlying this average is a wide range of forecasts for the third quarter of 2020, with quarter-to-quarter annual growth rates ranging from 0% to about 70%.

Clearly, there is no consensus among the forecasters about growth in the third quarter. In the past, when there was such as divergence in view, the highest and lowest forecasts would be excluded from the average. For the third quarter of 2020-21, this would result in a lower estimate of growth, thereby resulting in a larger decline than the 6.8% for the year as a whole.   This adjustment, together with needed program extensions, will result in a deficit closer to $400 billion.
And third, the snapshot assumes a bounce back in growth in 2021. Nominal income – a broad measure of the applicable tax base – is  forecast to return to its pre-COVID-19 level.

So what next for the government and the Finance Minister? To put it mildly their fiscal credibility is on the line even more now than before the snapshot. “Snapshots” and even a fiscal update will not be good enough. Mr. Morneau will have to present a full budget in the fall.

The primary objectives of a fall budget will be to quell fear, reduce uncertainty, and create confidence.  Without renewed confidence, among consumers and investors, economic growth will not recover.

But restoring confidence and establishing fiscal credibility won’t be easy.of a fall budget will be to quell fear, reduce uncertainty, and create confidence.  Without renewed confidence, among consumers and investors, economic growth will not recover.
But restoring confidence and establishing fiscal credibility won’t be easy.

Who decides if fiscal policy is credible? In our experience’ there are four key groups who will be critical to assessing the fiscal credibility of a fall budget. First, the fiscal plan in the budget must have the approval of financial markets because their approval will be critical in determining the cost of borrowing for the government and by extension other borrowers.  For Mr. Morneau, Fitch must restore its top ratings for Canada based on the budget. If it doesn’t’ then the Finance Minister and government will be in trouble.

Second, the budget must have the support of major stakeholder groups, representing key sectors in the economy. They are important because they will be influencing consumption, employment and investment decisions. Getting their support will require extensive pre-budget consultations.

Third, the budget must have broad-based support among the media because the media will be critical in shaping public opinion and creating public support. This too will require considerable pre-budget discussions.

And finally, the budget must have support in the general public. The budget must carefully explain to Canadians why budget actions are necessary, the nature of the actions being implemented, and how such actions will affect them. Canadians must be convinced that the actions are fair and equitable and will lead to long-term benefits. This would go a long way to reducing fear and uncertainty.

There are four criteria that can be applied in actually assessing fiscal credibility. First, is the budget fiscal plan “realistic”? In other words, is the budget plan based on sound analysis and a careful and balanced view of economic and fiscal prospects, challenges, and risks? The snapshot clearly fails these criteria.

The “snapshot” foresees a fairly quick economic recovery to pre-COVID-19 levels of GDP. This is simply unrealistic. Several sectors of the economy – tourism, airlines, hotels, and restaurants – will take years to fully recover, if ever.  Without adequate childcare spaces, many second wage earners and single parent earners may not be able to go back to work. How elementary schools are opened may also necessitate more childcare or a stay at home parent. How does an economy open up without adequate childcare and the continued constraint of social distancing?

Second, is the budget fiscal plan “responsible” by committing to a sustainable fiscal framework that supports long-run economic growth through control of the accumulation of public debt.  Eventually the government will have to renew its commitment to a declining GDP ratio, but not necessarily in the fall budget.

The International Monetary Fund (IMF Blog July 10,2020) has summarized it very well:
“ Fiscal policy will need to remain supportive and flexible until a safe and durable exit from the crisis is secured. While the trajectory of public debt could drift up further in an adverse scenario, an earlier-than-warranted fiscal retrenchment presents an even greater risk of derailing the recovery, with larger future fiscal costs. Policymakers should prepare contingent plans that can be flexibly scaled to manage the health, economic and fiscal risks from recurrent outbreaks.”

In other words, the fall budget should still allow for temporary fiscal actions taken to cushion an economic decline (a second wave and program extensions) provided they do not lead eventually to permanent structural imbalances. Nevertheless, Mr. Morneau must commit to winding down and eliminating temporary income and job support programs when economic conditions allow. This is unlikely to happen until an effective vaccine has been developed, produced and distributed on a massive scale. This is unlikely to happen before2022.  At this point, he must commit to a new fiscal anchor.

An important question for the Finance Minister is who should pay for past, and future temporary income assistance programs. Mr. Morneau, and many others, seem to believe future generations should bear this cost. He is proposing to refinance short-term debt with locked in long-term financing at lower interest rates.

From a purely financing point of view this is very attractive, but it begs the question as to why future generations (our grandchildren) should pay for these programs since they will not benefit from them.  Current taxpayers should pay for this spending and any new Covid-19 spending, other than for childcare and healthcare. The Finance Minister should consider a temporary Covid-19 surcharge on the GST with appropriate rebate adjustments.

The third principle is that the budget plan must be seen as “prudent” by including special adjustments to allow for the possibility of forecast error and unforeseen events. This has been the case for most budgets since 1995, but the size of the prudence factor in the fall budget plan will need to be reassessed.

Finally, to be credible, the budget plan must be “transparent” by providing full disclosure of research and analysis. Without transparency, there can be no accountability, and without accountability, there can be no credibility.  Mr. Morneau must commit to working with parliamentary committees by actually appearing before them. Most importantly, the Finance Minister must reject the use of omnibus bills. Individual policy proposals would be sent to appropriate parliamentary committees for discussion and debate and eventually voted on in the House.

In assessing Paul Martin’s 1994 budget, all four groups-financial markets, stakeholder, media, and general public-gave it a thumbs down.  The Minister’s credibility was on the line. The 1995 budget satisfied the four basic principles of credibility and as a result received enthusiastic thumbs up from all four groups.
Mr. Morneau had better do whatever is necessary to get four thumbs up.

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