Canada: Canada elections mandate to impact public finances and monetary policy
October 23, 2015
Canada’s Liberal Party received a sweeping mandate for deficit spending and tax reform in the 19 October elections, which has implications for public finances and monetary policy. After an 11-week election campaign, Canadian voters took to the polls and elected a new Prime Minister, Justin Trudeau, the leader of the Liberal Party of Canada. The Liberals received an outright majority in the House of Commons, claiming 184 out of 338 seats. The sweeping new Liberal mandate will facilitate the deficit-financed fiscal stimulus that the party had campaigned on, marking a drastic shift from the previous Conservative government’s focus on fiscal consolidation.
Prior to the elections, polls suggested that the Liberals would narrowly edge out incumbent Steven Harper and the Conservative Party. The extent by which the Liberals actually emerged on top was largely unexpected. They now control 14 more than the 170 seats required for a majority in the newly expanded House of Commons, which recently increased its capacity to 338 seats from 308 seats. Prior to this election, the party had held a meager 36 seats. The drastic increase marks the largest seat gain in Canadian political history and is indicative of how Canadian voters have shifted their sentiments toward a more center-leftist stance. The Conservative Party, which had been in power since February 2005, won 99 seats, which is far fewer than the 159 seats it held prior to the election. The New Democratic Party, which had made substantial gains in the last parliamentary election, now holds just 44.
The main economic pillars of the Liberal party’s platform are its planned CAN 60 billion investment programs over the next 10 years, major tax reform, and a shift in Canada’s position on energy and climate change. Specifics regarding the substantial increase in investment have yet to surface, however, it is clear that it will focus on infrastructure projects. The Liberals plan on taking advantage of historically-low interest rates in order to finance such spending, boosting the budget deficit up to $10 billion annually over the next two fiscal years. Canada currently has a balanced budget, however, under then proposed Liberal platform the deficit is expected to climb. Despite the pressure on public finances, deficit levels will still be manageable and well below the G7 average. Regarding the impact of the proposed spending on economic growth, TD economists Derek Burleton, Vice President and Deputy Chief Economist, and Economist Brian DePratto stated that:
“From a growth perspective, our outlook is likely to change as policy is implemented and further details become available. It is difficult to assess exact impacts at this early stage, but should the Liberal infrastructure spending materialize, the program could boost annual growth in 2016 and 2017 by up to 0.1 and 0.3 percentage points respectively.”
The Liberals have also stated that they would revamp the taxation scheme of the previous government, giving a break to the middle class while increasing rates for wealthier Canadians. Middle-income Canadians will see their income tax fall from 22% to 20.5%, while a new tax bracket will be introduced for higher-income individuals. The income splitting and Universal Child Care Benefit instated by the Conservative government will also be replaced. Regarding energy policy, the Trudeau government will no doubt be more involved than Harper was on climate change, and leave carbon pricing schemes to provincial governments. Trudeau may also have better luck than his predecessor in negotiating the construction of the Keystone XL pipeline with his American counterpart. The pipeline would accelerate the delivery of Canadian crude to ocean terminals in the Gulf of Mexico, and thus would improve access to offshore markets for Canadian energy. The project was stalled by the Obama Administration, but a new face in the Prime Minister’s office may be able to restart negotiations.
From a financial perspective, the markets’ reaction to the surprise result has been limited. Canadian equities saw some gains, particularly those related to engineering and construction firms. Yields on 10-year Canadian bonds also inched up in the day following the election. Currently, yields on long-term government debt are sitting at historical lows, however they are likely to increase as the government pursues its ambitious spending agenda. The increased fiscal stimulus will take some pressure off the Bank of Canada, which has cut rates twice so far this year in an effort to mitigate the effects of last year’s precipitous fall in energy prices. Regarding how the Bank’s policy stance will be impacted by the election result, analysts from BMO Capital Markets, Chief Economist Douglas Porter, CFA, and Senior Economist Benjamin Reitzes have stated that:
“A firmer underlying GDP growth rate, even if it does prove temporary, would at the margin reduce the chances of further Bank of Canada rate cuts, and indeed could even bring the first rate hike somewhat closer. While we are keeping our rate call unchanged for now (the Bank to stay on hold over the next year, and finally starting to raise rates in early 2017), that may change if the Liberal proposals are soon put in place and, in fact, start boosting growth.”
Canada faces challenges going forward, not least of which are external, including slackened demand from Asia and low energy prices. It is difficult to anticipate at this stage whether the proposed spending by the Liberals will have more than a transitory effect on growth going forward as much depends on where and how the funds are invested.
The Central Bank projects that the economy will grow 1.1% in 2015 and 2.3% in 2016, according to its October Monetary Policy Report. Economic analysts who participated in this month’s FocusEconomics Consensus Forecast revised down their 2015 growth forecast by 0.1 percentage points and now expect the economy to grow 1.2% in 2015. Our panel also cut the 2016 forecast by 0.1 percentage points and foresees the economy expanding 2.0%.
Author: Robert Hill, Economist