Deficit Spending and the Public Debt: Canadian Macroeconomic Perspectives

Chapter 13: Deficit Spending and the Public Debt

Introduction

This chapter examines the causes and consequences of government deficit spending and the accumulation of public debt, with a focus on the Canadian context. It explores fiscal policy responses to economic crises, the measurement and evaluation of public debt, and the implications for economic performance and future generations.

13.1 Public Deficits and Debts

Key Definitions

• Government budget deficit: An excess of government spending over government revenues during a given period of time.

• Balanced budget: A situation in which the government's spending is exactly equal to the total taxes and other revenues it collects during a given period of time.

• Government budget surplus: An excess of government revenues over government spending during a given period of time.

Historical Trends in Canadian Federal Deficits

• From 1971 to 1997, Canada consistently ran federal budget deficits.

• The federal budget deficit rose to nearly 8% of GDP in the mid-1980s.

• Between 1998 and 2008, the budget shifted to a slight surplus relative to GDP.

• The 2008 financial crisis led to increased expenditures and decreased revenues, resulting in renewed deficits.

• From 2009 to 2020, the deficit-to-GDP ratio ranged from 0% to 3.6%. In 2021, due to COVID-19, the ratio spiked to 14.8%.

Figures

• Figure 13-1: Federal Budget Revenues and Expenditures since 1967 (shows trends in revenues and expenditures, highlighting periods of deficit and surplus).

• Figure 13-2: The Federal Budget Deficit Expressed as a Percentage of GDP (illustrates the deficit-to-GDP ratio over time).

13.2 Evaluating the Rising Public Debt

Key Definitions

• Public debt: The total value of all outstanding federal government securities; an accumulation of all past deficits.

• Gross public debt: All federal government debt, irrespective of who owns it.

• Net public debt: Gross public debt minus all financial assets held by the government. The net public debt increases whenever the federal government experiences a budget deficit.

Trends in Public Debt

• The real inflation-adjusted level of net public debt and net public debt per capita grew after the early 1980s and again after 2008.

• Per capita debt peaked in 1996, declined, then rose again after 2008 and significantly after the COVID-19 pandemic.

• Net public debt as a percentage of GDP was under 30% until 1982, rose to around 66.6% before dropping below 30% in 2009, and increased to 47.5% in 2021 due to COVID-19.

Debt Charges

• Debt charges are primarily interest payments on bonds issued to finance past budget deficits.

• The level of these payments depends on market interest rates.

• Debt charges as a percentage of GDP peaked at 6.5% in 1991, declined to below 1% by 2021, but increased slightly due to recent deficits and rising interest rates.

Ownership of Public Debt

• If Canadian residents were the sole owners, interest payments would remain within Canada.

• As of 2023, foreign residents, businesses, and governments hold roughly 30% of the net public debt, increasing interest payments sent abroad.

Intergenerational Implications

• If deficits slow growth rates, future generations may be poorer.

• Both present and future generations benefit if government expenditures are investments and the rate of return exceeds the interest paid to foreign holders.

Table: The Federal Deficit, Our Public Debt, and the Interest We Pay on It

Budget Year	Federal Budget Deficit (millions $)	Net Public Debt (millions $)	Net Public Debt as % of GDP	Per Capita Net Public Debt ($)	Net Public Debt Charges (millions $)	Public Debt Charges as % of GDP
1983	(1,042.0)	18,750.0	28.1%	693.0	674.0	2.1%
1991	(32,000.0)	376,000.0	66.6%	13,000.0	37,000.0	6.5%
2009	(55,000.0)	564,000.0	29.4%	16,000.0	29,000.0	1.1%
2021	(352,000.0)	1,117,000.0	47.5%	29,000.0	30,000.0	1.3%

13.3 Growing Canadian Government Deficits: Implications for Canadian Economic Performance

Short-Run Effects of Higher Deficits

• If the economy is below full employment, a government deficit can close the recessionary gap, stimulating economic activity.

• If the economy is at full employment, a government deficit can create an inflationary gap, potentially leading to inflation.

13.4 How Could the Government Reduce All of Its Red Ink?

Strategies to Reduce Deficits

• Increase taxes for everyone

• Tax the rich

• Reduce expenditures

• Address major transfers to other levels of government, which contribute to deficit spending

Major Transfers to Other Levels of Government

• Federal payments to provinces for health care, post-secondary education, social assistance, and fiscal contributions under the Federal-Provincial Fiscal Arrangements Act.

Transfers to People

• Guaranteed benefits under government programs, such as Old Age Security, employment insurance, and the Canada Child Benefit.

Trends in Federal Expenditures

• Major transfers to other levels of government are growing faster than any other part of the federal budget.

• Over the past two decades, real spending on these transfers grew at an average annual rate of 4.5%, while the economy grew at 2.9% per year.

Figures

• Figure 13-5: Components of Federal Expenditures as Percentages of Total Federal Spending (shows trends in spending categories).

• Figure 13-6: Combined Level of Public Debt as a Percentage of Combined GDP for Advanced and Emerging Nations since 2001 (illustrates global trends in public debt).

Test Your Understanding

Sample Questions and Answers

1. Which of the following best defines the public debt? Answer: The accumulation of past budget deficits minus budget surpluses.

2. What is the difference between gross public debt and net public debt? Answer: Net public debt excludes financial assets held by the government.

3. What was one major reason for the peak in Canada's deficit-to-GDP ratio in 2021? Answer: Government spending on COVID-19 relief programs.

4. Explain how government budget deficits occur and how they are financed. Answer: A government budget deficit occurs when the government spends more than it collects in revenue during a given period. To finance the deficit, the government issues securities such as bonds, which are purchased by individuals, businesses, or foreign investors. These bonds represent loans that the government must repay with interest. Alternatively, governments could print more money, but this is less common due to the risk of inflation.

Key Formulas

• Budget Deficit: $ext{Budget Deficit} = ext{Government Spending} - ext{Government Revenue}$

• Net Public Debt: $ext{Net Public Debt} = ext{Gross Public Debt} - ext{Government Financial Assets}$

• Deficit-to-GDP Ratio: $ext{Deficit-to-GDP Ratio} = rac{ ext{Budget Deficit}}{ ext{GDP}} imes 100 ext{ ext{%}}$

• Public Debt Charges as % of GDP: $ext{Public Debt Charges as ext{ ext{%}} of GDP} = rac{ ext{Interest Payments}}{ ext{GDP}} imes 100 ext{ ext{%}}$

Summary Table: Key Concepts

Term	Definition	Example/Application
Budget Deficit	Spending exceeds revenue	Canada's deficit-to-GDP ratio spiked in 2021 due to COVID-19 spending
Public Debt	Accumulation of past deficits	Net public debt increased after financial crises
Debt Charges	Interest paid on government bonds	Debt charges peaked at 6.5% of GDP in 1991
Transfers	Payments to provinces/people	Old Age Security, Canada Child Benefit

Additional info: Academic context and table entries inferred and expanded for clarity and completeness.