Is Canada’s Federal Debt a Cause for Concern?

Canada’s federal deficit is expected to be more than 15% of GDP in the fiscal year 2020-21. The government’s response to the COVID-19 pandemic is to blame for the deficit and debt. The federal budget is expected to continue to have deficits beyond 2020. This commentary talks about how we should think about the federal government’s debt, and what perspective we should take that may be different from how we are used to thinking about other kinds of debt

The introduction is about something

The government of Canada is forecasting a large budget deficit this year due to the response to the COVID-19 Pandemic. Some analysts are concerned about the possibility of budget deficits beyond the pandemic. What will happen if fiscal policy continues? There are limits to how much debt can grow. Will inflation and interest rates go up? Will the exchange rate go down? The government might be in danger of not paying. Will austerity measures be implemented? Will we be passing the burden of repayment on to our children if the debt is not paid back?

None of the questions I will answer are of the good kind. Not directly. . I want to talk about how we should think about the federal debt, which may be different from the way we think about debt in general. I want to see where this perspective leads us in terms of determining possible answers to the questions posed

Over the years, various economists have pointed out that the federal government debt is not the same as debt[1] Most of us have a view of debt that is very personal. Even if we have to work harder or cut back on our spending, we will have to pay back our debt. If the practice was legal, most of us wouldn’t want to pass our personal debt on to our children. It would be easy to explain the federal debt as personal debt. This analogy is not perfect. The analogy is broken down for four reasons

A household has a finite lifespan. While a household must eventually retire its debt, a government can roll over its debt indefinitely. When debt comes due, it has to be repaid. New debt can be replaced with old debt. Rolling over the debt means that it will never be paid back. It may even be possible grow Over time, the economy’s operations are measured by the scale of the economy’s operations

The federal debt is mostly issued by the GoC. GoC securities were an important part of the money supply prior to the Bank of Canada[2] GoC securities are mostly electronic ledger entries. According to the person The two people of the year are Gungor and bulusuAbout $500 billion of short-term debt contracts are traded Each month GoC securities are used as a security. Most of these transactions are done with cash[3] The investors value the liquidity of GoC securities and they trade at a premium. The same way we are willing to carry insured bank deposits at very low interest rates is used by investors to carry GoC securities

The federal government has ultimate control over the legal tender. If the government permits it, a technical default can occur since the federal debt consists of GoC securities promising payment. The situation is similar to that of a corporation financing itself with debt and then issuing equity. It is impossible to be voluntary[4] This aspect of GoC securities makes them very desirable for investors who want to be safe, a property that drives down their yields relative to other securities

Domestic private sector wealth is defined as the amount of federal debt held domestically. The extent to which it is Net There is no doubt that some of the wealth is viewed in this way[5] The implication is that increasing the national debt makes people wealthier. Deficit-financed tax cuts can help boost private spending in a depression, making everyone better off. When the economy is at or near full employment, such a policy is more likely to increase the price level, generating a redistribution of wealth

We should consider looking at the federal debt from a different perspective. It seems more accurate to see federal debt as a form of quasi-money in circulation. The securities in the federal debt are valued the same way as money is, as a safe store of wealth. It makes no sense to have to pay back money already in circulation. It doesn’t mean there is nothing to be concerned about, even though not having to worry about paying back the federal debt does not mean there is nothing to be concerned about. If federal debt is a form of money, then the concern is not

Debt service

GoC securities bear interest, unlike the previous notes, and they can be sold at a discount. Even if the national debt doesn’t have to be paid back, it still needs to be serviced. Carry cost is interest expense associated with carrying debt

Corporate practices seem to have a large influence on debt management strategies employed by government departments. Governments can rely on their central banks to support their operations in a crisis, but corporations have to worry about rollover risk. Corporations operate on behalf of a narrower set of interests than a federal government. It is not clear whether corporate debt management principles apply to the Department of Finance

One could draw on the corporate sector for an example, and that of a bank is an example. Banks issue a lot of debt in the form of insured deposit liabilities. Because insured deposits are safe and money, investors are willing to carry low yielding deposits. Deposits are a cheap source of funding. Higher-return assets, such as mortgages and business loans, are carried out by using this low-cost source of funds. The net carry cost of debt is negative. The national debt, which is willingly carried by investors at relatively low yields, might be applied to if the federal government invests in programs designed to enhance productivity

Even if government expenditures don’t generate a high rate of return, the federal government can still carry its debt at a negative rate. If the national debt interest rate was less than the growth rate of the economy, this would be true. The government is in a position to run a primary budget deficit indefinitely if r g is the case. Even if the interest rate on the debt is positive, the effective carry cost of the debt is negative[6] The history of r and g for Canada is shown in Figure 1

The debt is being Monetized

The composition of the debt between currency, reserves, bills, notes, and bonds is a factor that influences the average interest expense. Monetary policy is a factor in determining the composition of the debt. The BoC purchases GoC securities in order to swap lower-yielding reserves for higher-yielding GoC securities. The BoC’s composition of its liabilities is determined by the demand for currency, which is thought of as a zero-interest government security

BoC holdings of GoC securities have increased recently in the form of interest-bearing reserves. The implication is that private banks are now holding large quantities of interest-bearing reserves that are not much different from GoC securities. In the past, debt in present circumstances is usually converted into zero-interest securities, but in this case it is not the same

The debt-to-GDP ratio is the most important factor in determining how large of a primary deficit the government can run. The debt-to-GDP ratio is determined by the market demand for debt, which in turn depends on a host of factors, including the structure of interest rates, which are themselves determined or influenced by the BoC. The debt-to-GDP ratio is increased by an increase in debt. The debt-to-GDP ratio depends on the denominator. It is possible that an increase in debt will cause the price level to rise and the debt to GDP ratio to fall, which will cause the nominal GDP to rise and the debt to GDP ratio to fall. There is a limit to how much the market can absorb in the way of GoC securities, for a given price level and structure of interest rates. No one knows how high the debt-to-GDP ratio can get. We can’t know where the limit is until we get there


The purchasing power of nominal wealth is related to the price level. A higher price level means that your money buys less stuff. The rate of change in the price level is called inflation. It is important to remember that the rate of inflation can change in a short time, but it can also change in a persistent way. It is difficult to disentangle these two concepts in real time, but it is important to make the distinction

The market is willing to absorb nominal government paper for a given structure of prices and interest rates, but it is not large. A one-time increase in the supply of debt that is not met by a corresponding increase in demand is likely to cause a change in the price level or interest rate. An ongoing issuance of debt that is not met by a corresponding growth in demand for debt is likely to cause inflation. BoC policy affects the interest rate on GoC securities

There is no reason to be concerned about a growing national debt if inflation remains below a tolerable level. The government is not concerned with the prospect of a firm going into default. A firm that exercises its conversion option is likely to experience share dilution. A government that monetizes debt is likely to see a jump in the price level. The underlying events triggering the option are likely to have more to do with the resulting dilution than with the conversion. A company or government that suddenly finds itself under fiscal pressure will have to deal with it in many ways, whether through cost-cutting measures, default, or dilution

If inflation rises persistently above a tolerable level, what will happen? The BoC and the government in Canada determine an inflation target. The target is 2% per annum, with a tolerance band of 1 to 3%. If inflation were to increase and remain above 3%, the BoC might have to reduce its purchases of GoC securities. The effect of this would be to put upward pressure on bond yields. Private sector wealth and cost of borrowing would be reduced by higher interest rates, which would in turn reduce private sector spending, slowing economic growth. The government would have to pay more for its carry cost if interest rates were to go up. This could result in a set of government austerity measures that could slow economic growth, like the episode Canadians experienced in the early and mid 1990s

If the pace of debt issuance is slowed, this will not be a problem. There is no way of knowing how large the national debt can get before inflation becomes a concern. The consumer price index has spent most of its time near the lower part of the target band of 1 to 3% since the financial crisis of 2008. We can’t say for certain that inflationary pressures are contained. It would be wise for the government to have a plan in place to deal with this contingency. The plan might allow for inflation to overshoot the upper band of the target for a period of time as tax and spending legislation is changed[7]


The COVID-19 pandemic has caused a recession, but it is different from the other recessions. Private sector spending tends to decline in excess of what might be justified by any change in underlying fundamentals. The COVID-19 shock has caused a contraction in some sectors of the economy that serves a clear social purpose, preventing the spread of the virus

A fundamental shock in one sector should cause changes in the level of economic activity in other sectors. Aggregate output on net is likely to decline. FiscalStimulus designed to boost overall aggregate demand is not in order if this rearrangement of activity is a desirable response to the shock

Credit conditions are generally tightened by a shock of this nature. Businesses and individuals cut back on spending when the economy is uncertain. Some fiscalStimulus may be in order if this fear is self-fulfilling

It seems clear that social insurance is in order even without a fiscalStimulus. If voters were afflicted with the Pandemic shock, they would likely want the Canada Emergency Response Benefit to be used to maintain the income of those who suffered income losses. If aggregate output declines and income support is financed by a one-time increase in the national debt, the result is likely to be a one-time increase in the price level

Canadians should be prepared for a burst of inflation. It is not inevitable that a higher price level will be reached since demand for GoC securities will be dependent on how the economy performs. If inflation goes past 3%, this will not be a sign of tighter monetary or fiscal policy. The mechanism through which purchasing power is redistributed across individuals is understood to be the higher price level[8]

[2] See The staff working paper was published by the bank

[3] Repo is a short-term lending arrangement in which a party needs cash and sells a security and agrees to pay back the loan the next day. The creditor keeps the security if the repurchase fails

[4] The presumption is that the BoC must support the Department of Finance in its operations

[5] Federal debt is not net wealth to the extent that people hold it in anticipation of higher taxes Barro was born in 1974

[6] The interest expense of the debt is not included in the primary budget deficit

[7] I want to emphasize that austerity should not be imposed on those most vulnerable in society. Program spending can be cut if funding shortfalls are allocated to sectors of the economy that are better able to absorb shocks

[8] Money transfers that are received still come ahead even though the price level increases for everyone. The cost of living has to go up because output is lower. Purchasing power is lost if those who do not receive transfers do not receive transfers. The effect is to transfer power from the fortunate to the unfortunate. The effect of a higher price level is to increase the nominal GDP

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