44% Chance Canada’s Federal Debt Will Increase Over 10 Years: Study

Copies of the “2023 Fall Economic Statement” are seen in the media lockup immediately prior to the release of the statement, in Ottawa on Nov. 21, 2023. (The Canadian Press/Justin Tang)

In a recent Fraser Institute study, experts raised concerns about the trajectory of Canada’s current fiscal policies, highlighting a significant chance of the federal debt increasing as a percentage of the economy over the next decade.

Titled “Adrift without an Anchor: Federal Fiscal Policy and Canada’s Long-Term Debt Ratio,” the study suggests a 44 percent likelihood that the net federal debt-to-GDP ratio will be higher in 2036–37, and a 59 percent chance it will be higher in 2046–47.

This means the federal government “would fail to stick to its core fiscal goal,” said a Feb. 1 press release from the public policy think tank.

“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 that will result in larger budget deficits,” Jake Fuss, director of fiscal studies at the Fraser Institute, said in the press release.

The federal debt-to-GDP ratio is a key economic indicator, reflecting the connection between a country’s federal government debt and its gross domestic product (GDP). The ratio gauges the government’s fiscal health and capacity to fulfill financial obligations. A higher ratio indicates a relatively larger debt compared to economic output, signalling potential fiscal challenges. Conversely, a lower ratio signifies a more manageable debt burden relative to the overall size of the country’s economy.

‘Not Credible’

In the “2023 Fall Economic Statement,” the federal government outlined three fiscal policy objectives in preparing for Budget 2024. One was keeping the 2023–24 deficit at or below the Budget 2023 projection of $40.1 billion. Another was lowering the debt-to-GDP ratio in 2024–25 and ensuring a continued decline thereafter. The third objective was to keep deficits below 1 percent of GDP in 2026–27 and subsequent years.

Referencing these commitments, the Fraser Institute study noted that, in reality, the federal government has postponed reducing its deficit since the COVID-19 pandemic, and instead continued to revise program spending upward.

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The researchers pointed out that this trend is evident in the continual revision of the federal government’s projected budget deficits as a percentage of GDP in recent years.

Budget 2022 anticipated a deficit of $8.4 billion in 2026–27, or about 0.3 percent of GDP. However, a year later, Budget 2023 revised up this projection to $15.8 billion, or 0.5 percent of GDP. Then, seven months later, the 2023 Fall Economic Statement released in November further ramped up the projected deficit to $27.1 billion, or 0.8 percent of GDP.

“We conclude that the federal government’s claim that its fiscal policies will lead to a downward trend in its debt ratio is not credible because it ignores the likelihood that future recessions will result in larger budget deficits,” the researchers said.

Debt ‘Doom Loop’

“The deterioration in the federal fiscal position over the past year, with larger projected deficits, interest rates, and debt levels, has increased the likelihood of higher debt ratios in the future,” the Fraser Institute press release said.

On top of that, it said a major economic downturn, such as a recession, would directly impact public debt, due to declines in government revenues and increases in government spending, and ultimately result in larger budget deficits.

The think tank warned that a recession’s direct and indirect efforts could trigger a debt “doom loop,” where debt will continue to rise relative to the size of the economy if the government doesn’t act quickly to reduce its post-recession budget deficits.

“The combination of the high likelihood that Ottawa will miss its current fiscal goal coupled with the pattern of abandonment for previous fiscal goals, indicates the federal government lacks any sincere initiative to hold itself accountable with effective fiscal rules or constraints,” Mr. Fuss said in the press release.

“It is critical policy-makers 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 meaningful government spending restraint that would keep federal finances in check.”

The Fraser Institute study was conducted by Bev Dahlby, a senior fellow at the institute, and Ergete Ferede, an economics professor at MacEwan University in Edmonton.