Federal Government Spending: Neither the Sole Cause of, nor Solution to, Our Inflation Woes

The federal government has come under significant fire for the inflationary impacts of its pandemic spending. This has prompted calls for austerity from some quarters, particularly as expenditures are expected to remain elevated as a share of GDP for the foreseeable future. However, we think federal austerity would be a mistake. First, federal program spending is already rapidly declining and is forecast to advance in line with inflation over much of the outlook. Second, many of the spending categories that aren’t already declining are transfers to low-income households or negotiated transfers to provinces. Third, provinces will collectively see spending fall more slowly than the federal government, suggesting they may have more room to reduce spending. Fourth, the government sector in Canada looks to be on a more sustainable path than the housing market and other interest rate sensitive parts of the economy. As tough as the adjustment is going to be, interest rates need to rise to restore balance to asset markets and bring down inflation. And the burden of responsibility for returning inflation to target falls squarely on the Bank of Canada.