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Funding Today, Fiscal Deficit Tomorrow

June 29, 2020

A novel virus has the ability to launch the world into a global pandemic, shaking up the economy of every country, and transforming the very notion of what is considered “normal” day-to-day living standards. That is exactly what COVID-19 has accomplished and will forever go down in history textbooks. The impact of a global pandemic in this day and age brought upon an immediate shock to the world, causing business owners, households, and governments to act rapidly and respond with unprecedented actions, without a clear deadline for when it will be safe to operate again. The main priority was to establish appropriate health and safety measures to ease the spread of the novel virus. It has led to nationwide shutdowns across operations that are not deemed essential, including businesses, academic institutions, and even recreational parks. Aside from the need for consumer staples and everyday essentials to survive, the country was hungrier for one particular essential, liquidity.

Governments globally began to construct stimulus plans and relief packages to respond to the needs of liquidity. The prompt injection of liquidity was critical, as we began to see extraordinary capital being pumped into the economy. In Canada, governments across the country were spending a remarkable amount to help curb the impact of COVID-19 in response to the diminishing economy. On a federal level, the emergency stimulus initiative has totaled more than $146 billion (Parliamentary Budget Officer, 2020), with indications that more stimulus tools will be required, as long as COVID-19 continues to be a concern. The PBO modeled an economic scenario noting that the federal budget deficit may total $252 billion, with a debt-to-GDP ratio of 48% by 2021. Compared to pre-crisis figures of $24.9 Billion in fiscal deficit and a 30.9% debt-to-GDP ratio. Now, you are probably wondering how on earth are we going to pay this off?

To break things down, the large increase in the deficit was implemented to support temporary ramifications. In addition, part of the spending was issued to address the sharp economic decline due to the halt in business activities. Both support plans are expected to gradually retract once the economy resumes to appropriate operating levels. With the aforementioned support programs in line with nominal GDP growth, it will be hopeful that the debt-to-GDP ratio will begin to stabilize over time, while assuming  the federal borrowing rate remains at conservative levels and below the nominal GDP growth rate.

What if the debt-to-GDP ratio does not gradually ease to conservative levels and the central bank’s balance sheet is still stretched? Many fear that a potential rise in taxes will be inevitable, borrowing costs will climb, and multiple support programs will be eliminated. Given that a tax hike is required, how should it be borne? Is it fair to inflict it on the upper class? Should the tax hike be uniformly distributed? Many are concerned over the expeditious and abundant of spending by the federal government. Rightfully so, as these actions pose a threat to future growth prospects across various sectors.

It is difficult to forecast with precision how the economy is going to rebound from the effects of COVID-19. We are truly living through unprecedented times, with no certainty of how things will unfold.