Deficit Spending and the Public Debt: Canadian Perspective (Macroeconomics Today, Chapter 13)

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Deficit Spending and the Public Debt

Introduction

This chapter examines the causes, measurement, and implications of government deficit spending and public debt, with a focus on the Canadian federal government. It discusses recent fiscal policies, especially those enacted during the COVID-19 pandemic, and analyzes trends in budget deficits and debt over time.

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, the federal budget consistently ran deficits.
In the mid-1980s, the federal budget deficit rose to nearly 8% of GDP.
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 1% to 3.6%.
In 2021, due to COVID-19, the deficit-to-GDP ratio spiked to 8%.

Federal Budget Revenues and Expenditures Since 1967

Figure 13-1 illustrates the trends in federal budget revenues and expenditures, showing that deficits (expenditures in excess of revenues) have been much more common than surpluses in Canada.

Year	Federal Revenues	Federal Expenditures	Budget Balance
1967-1997	Increasing	Increasing (faster)	Deficit
1998-2008	Stable/Increasing	Stable/Increasing	Surplus
2009-2020	Decreasing/Stable	Increasing	Deficit
2021	Decreased (COVID-19)	Increased (COVID-19)	Large Deficit

Additional info: Table entries inferred from the provided graph and text.

Evaluating the Rising Public Debt

Definitions and Measurement

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 Net Public Debt

The real inflation-adjusted level of net public debt per capita grew in the early 1980s and after the 2008 financial crisis.
Per capita debt peaked in 1996, declined, then rose again in 2008.
Net public debt and per capita net public debt increased significantly after 2020 due to the COVID-19 pandemic.

Net Public Debt as a Percentage of GDP

Under 30% until 1982.
Rose steadily to around 66.6% before dropping in 2009 to just under 30%.
Since 2009, remained under 35% until the COVID-19 pandemic, when it increased to 47.5% in 2021.

Debt Charges and Interest Payments

Debt charges are primarily interest payments on government bonds issued to finance past deficits.
The level of these payments depends on the market interest rate.
As a percentage of GDP, net debt charges peaked at approximately 6.5% in 1991, then declined to below 1% by 2021.
Recent deficits and rising interest rates have caused a slight increase in the ratio of net public debt charges to GDP.

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, meaning a significant portion of interest payments leave the country.

Intergenerational Implications

If deficits lead to slower growth rates, future generations may be poorer.
Both present and future generations can be better off if government expenditures are investments with returns exceeding the interest paid on debt.

Implications for Canadian Economic Performance

Short-Run Effects of Higher Deficits

If the economy is below full employment, government deficits can help close the recessionary gap.
If the economy is at full employment, deficits can create an inflationary gap.

Example: COVID-19 relief spending increased deficits but helped support aggregate demand during a recession.

Reducing Government Deficits ('Red Ink')

Methods to Reduce Deficits

Increase taxes for everyone
Tax the rich
Reduce expenditures

Major Transfers to Other Levels of Government

Federal government payments to provinces and territories for health care, education, social assistance, and fiscal contributions.
Transfers to people include guaranteed benefits such as Old Age Security, employment insurance, and the Canada Child Benefit.

Trends in Federal Expenditures

Component	Share of Total Spending (Trend)
Departments and Agencies	Declining
Transfers to People	Increasing
Transfers to Other Governments	Increasing
Debt Charges	Declining (until recent years)

Additional info: Table entries inferred from the provided graph and text.

Growth of Transfers

Real spending on major transfers to other levels of government grew at an average annual rate of 4.5% over the past two decades.
The economy grew at an average annual rate of 2.9% in the same period.

International Comparison of Public Debt

Public Debt as a Percentage of GDP: Advanced vs. Developing Nations

Group	Public Debt (% of GDP)	Trend Since 2001
Advanced Economies	Above 100%	Rising since late 2000s, remains high
Emerging/Developing Economies	Rising	Highest levels yet recorded as of 2021

Additional info: Table entries inferred from the provided graph and text.

Review Questions and Key Concepts

Definitions

Public debt: The accumulation of past budget deficits minus budget surpluses.
Gross public debt vs. net public debt: Net public debt excludes financial assets held by the government; gross public debt is always larger than net public debt.

Major Reason for Peak Deficit-to-GDP Ratio in 2021

Government spending on COVID-19 relief programs.

How Government Budget Deficits Occur and Are Financed

A government budget deficit occurs when government spending exceeds revenue (taxes and other sources) during a period.
To finance the deficit, the government issues securities such as bonds, purchased by individuals, businesses, or foreign investors.
These bonds represent loans the government must repay with interest.
Alternatively, governments could print more money, but this is rare due to the risk of inflation.

Key Formula

Deficit Calculation:

Debt Accumulation: