In Mid-January, the Finance Minister, Chrystia Freeland, announced new budget consultations with Canadians to assist her in preparing her spring budget. According to Minister Freeland, the 2021 budget “will be among the most significant of our lifetime.”

We have no idea what a “significant” budget means and we doubt that the Finance Minister does as well. All finance Ministers consider their budgets “significant” or “important”. We decided, therefore, to raise the bar and to replace “significant ” with “credible,” even though we also know there is no agreement among economists as to what constitutes a “credible” budget.

So who decides whether a budget or fiscal policy is credible and on what basis do they decide? In our combined over fifty years of experience in budget preparation, governments usually seek the approval of their budget and fiscal policies from four key groups.

First, governments seek the approval of financial markets because their approval will be critical in determining the cost of borrowing for the government, as well as for other borrowers in the economy.

Second, governments seek the approval of important stakeholder groups, representing business, labour, consumers and educational institutions to mention only a few. This is done through extensive pre- and post-budget consultations. They are important because it is these sectors that will make the decisions that will affect investment, output, and employment. They also represent the “talking heads” that the media will consult for their opinions. They can significantly affect public opinion by their reaction to government actions.

Third, governments will also seek the approval of the media, both domestic and international, because the media is critical in shaping public opinion. If initial media reaction is negative, then it could be difficult to change their observations and conclusions.

Fourth, governments must seek the approval of elected bodies and the general public. They must carefully explain why action is necessary, the nature of the actions being considered, and how such actions affect them. The public must be convinced that actions are necessary, that they are equitable and that they will lead to long-term benefits, even though there may be some short-term pain.

What do these groups consider in deciding if fiscal policy is “disciplined” or “credible”? In our experience, these groups consider four criteria in making their judgment.

First, fiscal policy must be realistic. By that we mean fiscal policy should be based on sound analysis and a careful and balanced view of economic and fiscal prospects, challenges and risks. Economic forecasts and fiscal policy should not be based on  “rosy” or unrealistic views of future economic and fiscal prospects.

Second, fiscal policy must be responsible. This means the government must be committed to establishing and maintaining a sustainable medium or longer-term fiscal framework, one that supports long-run stable economic growth through control of the accumulation of public debt.

Third, fiscal policy must be prudent by including a reasonable amount of “insurance” to guard against forecast errors and the impact of unforeseen events and necessary policy actions.

Finally, fiscal policy must be transparent. This means providing full disclosure of analysis and information since, without this, independent experts will not be able to assess how realistic the economic and fiscal forecasts are. Without transparency, there can be no accountability. Such analysis should not be restricted to the current planning period, but also identify potential risks in the future

With these criteria in mind what will Minister Freeland have to do in the coming weeks and months to help make the “2021 budget among the most “credible” budget in our lifetime?” Up until now most Canadians probably consider the 1995 budget to be the most credible budget in that it satisfied all four criteria.

Given the current context of the COVI-19 crisis, and the necessary shutdown of the economy, the Minister has some very tough challenges ahead in planning her budget. A critical ingredient of any economic recovery will be consumer and investor confidence and right now both are seriously lacking. Notwithstanding the high levels of consumer and corporate liquidity, the amount and timing of consumer and investor spending is uncertain. A successful vaccine rollout is a precondition to any economic recovery and by extension a credible budget.

The Minister’s Mandate letter (January 15, 2021) sums up her short and long-term budget challenges.

Preserve Canada’s fiscal advantage and continue to be guided by values of sustainability and prudence by presenting a plan to regrow the economy and presenting a new fiscal anchor to guide this work. You will use whatever fiscal firepower is needed in the short term to support people and businesses during the pandemic, and will keep supporting the economy with emergency measures until the economy improves. Doing so, you will avoid creating new permanent spending. You will also lead the creation of a resiliency agenda for Canada’s longer-term post-pandemic economic recovery, including actions to transition to a greener, more inclusive and more prosperous economy. You will also review our debt management strategy.

In addition to all that the Minister must:

“Foster a professional and respectful relation ship with journalists to ensure that Canadians have the information they need...”

Perhaps most importantly, Minister Freeland will need an effective pre-budget consultation and communication strategy for all four groups. This is difficult and unlike any previous budget consultations because the virus makes it impossible for her to meet face to face with all four groups.

In our view the most important group that will determine fiscal credibility are financial markets. The Fitch rating agency downgraded Canadian debt last July and indicated at the time that they would consider a further downgrading depending on the Minister’s budget. Interest rates may be low but financial markets can still impose brutal risk premiums on borrowers.

Fortunately, unlike the early 1990s, there is no immediate fiscal crisis but there is a major fiscal problem. The Minister is now confronted with a deficit of just under $400 billion for 2020-21 compared with just under $40 billion in 2019-20. The debt ratio is now just over 50 per cent of GDP compared to just over 30 percent in 2019-20.

The Minister will have to set out a fiscal strategy for reducing the deficit to an “acceptable level” and reducing the debt burden over a “reasonable” time period.  This does not mean adopting a policy of fiscal austerity, as was the case after the 2008-2009 financial recession. Growth through austerity was a failed strategy after 2008-2009 in Canada and in the EURO area.

Nevertheless, financial markets will want to see a clear commitment to fiscal prudence and a credible fiscal anchor once the recovery has matured. Unfortunately for the Minister, experience in other countries and past experience in Canada provide little help in choosing a fiscal anchor. A credible fiscal anchor depends entirely on the willingness of a government to make tough political decisions. Perhaps this is why fiscal anchors have rarely succeeded.

Last December, the Minister presented her Fall Economic Statement 2020 (Update) to formally start the process of budget consultations. In developing the economic assumptions underlying the Update, the Minister met with private sector economists to get their views on economic prospects and challenges.

In January of this year, she met again with private sector economists to get their updated views on economic prospects. She needs their views on the timing and strength of the short-term economic recovery, how much stimulus spending might be required and for how long. She also needs their views to ensure the credibility to the economic assumptions used to developing her upcoming budget. Here the Department of Finance should present much more information on the details of the economic and fiscal forecasts, as is currently done by a number of provincial governments.

According to her Mandate letter, she is to use whatever “fiscal firepower is needed” and to continue doing so “until the economy improves”. In doing so she is to avoid creating “new permanent spending” programs. In her December Update, the Finance Minister committed to $70 to $100 billion of stimulus spending over three years, although the funds were not explicitly included in the Update’s fiscal projections. She was unable to say what would be in the stimulus spending and little is known of their recovery plan even today.

Some have argued that the employment rate should be used as a “fiscal guardrail” in determining the amount and duration of the stimulus spending. The employment rate measures the number of people working in relation to the working age population. To put that in context for the economic recovery, the employment rate in 2008 was 62.3% and in 2019, it was 61.9%. In January 2021, it had fallen to 58.6%.

To restore the employment rate to its 2019 level in three years would require the creation of an additional 1.6 million jobs in 2023-24. It would take annual economic growth in the 4 to 5 per cent range to generate that many jobs in 2023-24. This is highly unlikely. Private sector forecasters and the Bank of Canada are forecasting growth of around 4 per for this year and next year but only 2.5 per cent in 2022. The Minister should be very careful in setting employment targets that will be difficult to achieve.

Having said that, we believe the Minister should error on the side of “too much” stimulus rather than “too little”. This also means extending the duration of the stimulus spending from three to four years, and front end loading the spending. The composition of the stimulus spending is just as important as the amount of spending. In all likelihood, the size of the stimulus package will be the main focus of criticism in the budget.

Critics of large stimulus will argue that, with the excessive liquidity already in the economy, this could lead an outbreak of inflation. This argument against large stimulus was successfully used after the 2008-09 financial recession and resulted in a decade of economic underperformance and a constant risk of deflation not inflation. Should signs of inflationary expectations begin to emerge, then the Bank of Canada has more than enough policy tools to deal with it.

The Minister has been meeting “virtually" with other major stakeholders, and the House of Commons Standing Committee on Finance will soon send its pre-budget consultation report to the Minister. The Minister has also been appearing on a number of media outlets.

In January, the Minister released an on-line questionnaire for Canadians, which is aimed at finding out the budget priorities of Canadians. Unfortunately, Canadians don’t appear to be very interested in the budget right now. Their primary interest is when they will get vaccinated which, given the way things are going, is not likely to be until after the budget. Given the Minister’s skills as a financial journalist, she might want to consider writing policy commentaries in international and domestic media. She needs to do something to generate some interest in her budget and, to get factual information into the public domain.

Last fall, the Government was telegraphing that after the economic recovery, which could take three to four years, they were prepared to run on-going structural deficits in order to finance the “investments” critical for strengthening competitiveness and long-run potential economic growth. After all long-term interest rates are currently very low and the Government would be derelict not to take advantage of them.

Since then there has been a shortage of new information of the government’s long-term strategy. Investments in the “green” economy were announced last year. The only new information was The Prime Minister’s announcement this week of  $14.9 billion on public transit funding over eight years beginning in 2026-27. This appears to be an extension of the existing infrastructure program already in the fiscal plan and which for years has been seriously underspent.

Despite lots of rhetoric there has been very little information on what the government is seriously thinking on health care, pharma care, childcare, and long-term home care, all areas of provincial responsibility. As an aside, if the government really wants to do something for economic growth, perhaps it should consider a commitment to reform the income tax system or actually getting rid of internal trade barriers. Free trade within Canada would have a significant impact on GDP.

There is a basic but very important “rule” in budget planning that on budget day there should be no surprises. This has been true for all budgets for the last forty years, some with great success and others with little success. The government needs to a lot more to avoid breaking this rule.