30 Percent Chance of Government Failing Fiscal Goal of Reducing Federal Debt Over Next Decade: Study

The Parliament Hill Peace Tower is framed in an iron fence on Wellington Street in Ottawa on March 12, 2020. (Sean Kilpatrick/The Canadian Press)

With a little over a week before the federal government releases Budget 2023, a stress test of the current fiscal policy shows that Ottawa has a 30 percent chance of failing to achieve its core fiscal goal of reducing federal debt over a 10-year period, says a Fraser Institute study.

The study, titled “Stress Testing the Federal Fiscal Anchor,” was co-authored by Bev Dahlby, senior fellow at the Fraser Institute, and Ergete Ferede, professor of economics at MacEwan University in Edmonton.

Prior to the COVID-19 pandemic, the government’s fiscal anchor was to maintain its debt-to-GDP ratio at 30 percent. But with federal borrowing to finance the massive pandemic-related spending, the debt ratio shot up to 47.5 percent in 2021, the authors said in an executive summary released on March 16.

Instead of introducing a fiscal restraint to bring the debt ratio back to the previous level, the government embraced a new fiscal anchor of gradually reducing the debt-to-GDP ratio over the next 45 years—a goal that is based on assuming a constant annual economic growth rate of 1.6 percent.

This assumption of constant economic growth, however, contradicts historical experience, the authors said.

“The federal government has committed to gradually reducing federal debt as a share of the national economy over the medium term, but they have not accounted for the impact of recessions, which will make it difficult to achieve this stated goal,” Jake Fuss, senior fellow at the Fraser Institute and co-author of the study, said in a press release.

The study also noted that the government projections have excluded forecasts of recessions in the future. The authors noted that there is a 32 percent chance of a recession happening in the next 20 years. There is also a 28 percent chance that two recessions will occur in that time frame, which will drive up the possibility of increased federal debt-to-GDP ratio to 60 percent, according to the press release.

The authors warned that direct and indirect effects of a recession could set off a debt “doom loop,” meaning that debt will continue to increase relative to the size of the economy if the government does not quickly respond by reducing its post-recession budget deficits.

“The combination of the high likelihood that Ottawa will miss its current fiscal goal coupled with the abandonment of previous fiscal goals, indicates the federal government lacks any effective fiscal rules or constraints,” Fuss said.

“It is critical policymakers evaluate how major economic downturns like a recession could affect the public debt in the future, and conclude the best way to lower budget deficits and public debt is through government spending restraint that would keep federal finances in check.”