Canadians are eagerly awaiting the fiscal update from Finance Minister Chrystia Freeland. However, according to economists at Scotiabank Global Economics, if governments had shown more restraint in their spending, interest rates in the country would be significantly lower. The economists argue that 200 basis points, or two percentage points, of the Bank of Canada’s current 5% interest rate were necessary to counteract the inflationary effects of government spending and pandemic relief to households.
Government spending has been outpacing GDP growth at all levels since 2019, leading to a surge in stimulus that fueled inflation. The economists calculate that government spending accounted for 120 basis points of the 475 basis points the central bank has raised its rate since March 2022. Provincial spending contributed 70 basis points, the federal government added 30 basis points, and municipalities and other levels of government accounted for 20 basis points. In addition, COVID-19 relief to households contributed about 80 basis points, bringing the total impact to two percentage points.
While the economists recognize the need for some increase in spending to accommodate population growth and the increasing number of elderly Canadians, they argue that these expenditures were inconsistent with inflation control and led to higher interest rates. They highlight that fiscal policy can be a powerful tool to combat economic shocks but can also create problems when support becomes too excessive or enduring.
The report from Scotiabank echoes concerns raised by other economists who believe that government spending is complicating the Bank of Canada’s ability to manage interest rates effectively. Bank of Canada Governor Tiff Macklem has also urged lawmakers to consider the inflationary impact of their spending plans. The economists at Scotiabank stress the importance of recalibrating fiscal policy to avoid repeating the same errors in future budgets.
FAQs
How has government spending impacted interest rates in Canada?
According to economists at Scotiabank, government spending and pandemic relief to households have contributed significantly to higher interest rates in Canada. They estimate that 200 basis points of the Bank of Canada’s current 5% interest rate were necessary to counteract the inflationary effects of government spending.
What sectors of government spending have contributed to higher interest rates?
The economists calculate that government spending at all levels has contributed to the increase in interest rates. Provincial spending accounted for 70 basis points, the federal government added 30 basis points, and municipalities and other levels of government accounted for 20 basis points.
What is the impact of COVID-19 relief on interest rates?
The economists estimate that COVID-19 relief to households accounted for approximately 80 basis points, bringing the total impact of government spending and relief measures to two percentage points.
What is the concern regarding government spending and interest rates?
Economists warn that excessive and prolonged government spending can complicate the Bank of Canada’s ability to manage interest rates effectively. They stress the importance of recalibrating fiscal policy to ensure inflation control and avoid higher interest rates in the future.