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HomePolicy Articles Article Summary

Debt Accumulation, Debt Reduction, and Debt Spillovers in Canada, 1974-98

Public Policy Paper by Ron Kneebone, John Leach

To a certain degree, the amount of debt a government accumulates is beyond its control. Recession means a loss of tax revenue, an increase in certain expenditures and an increase in debt. Debt accumulation from this source should, however, be of limited duration. One source of change in the debt-to-output ratio is not outside the control of the fiscal policy maker. This is what is called the structural component. By setting tax rates and spending propensities, a government is able to determine the rate of growth in the debt-to-output ratio when the economy is operating at maximum sustainable output. The structural component should not contribute to debt accumulation.

Little responsibility for the increase in the debt-to-output ratio at the sub-national level can be levelled at the fiscal choices made by those governments. These governments were the victims of a cyclical component and were only saved by a favourable rate component. The same cannot be said of the federal government. The federal government’s structural component was responsible for a large fraction of the increase in the federal debt-to-output ratio. While it is certainly true that economic downturns and periodic run-ups in interest rates caused by tight monetary policy contributed to the federal government’s budgeting woes, it is also true that the sub-national sector, despite dealing with a less diversified, and hence more volatile, revenue base, largely avoided such poor choices.

The idea that, in a currency union, one government might, with profligate spending or unsustainable tax rates, impose costs on other members of the union by forcing up interest rates and slowing economic growth is behind the restrictions on the budgetary choices of member states of the EMU. Even our conservative measures show that profligate spending and/or unsustainable tax rate settings at the federal level, as evidenced by the large federal structural component, impose a large cost on the sub-national units, compared to that sector’s own structural component. Unfortunate circumstances, in the form of deep recession and slow recoveries, were the main reasons for increases in the debt-to-output ratio at the sub-national level. Federal fiscal choices caused the sub-national debt in 1998 to be higher by a minimum of two percentage points of GDP, or $16 billion. To that extent, the provinces were victims, not only of circumstances, but also, of the federal structural component.

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Policy Publication Details

Author(s): Ron Kneebone; John Leach;
Publisher: Saskatchewan Institute of Public Policy [ Visit Website ]
Year Published: 2000; Publisher Type: Research Institute
Publicly Available: Yes Research Focus: National;
Registration Required: No Language: English
Payment Required: No Publication Format: Adobe PDF

Subjects / Categories:

Policy Articles / Fiscal & Budgetary / Fiscal Federalism
Policy Articles / Monetary & Capital Management / Monetary Policy
Policy Articles / Economy / Federal Economy
Policy Articles / Economy
Policy Articles / Fiscal & Budgetary
Policy Articles / Monetary & Capital Management

Keywords / Tags:

debt accumulation; federal government; recession; loss of tax revenue; fiscal policy; tax rates; debt-to-output ratio; economic downturn; monetary policy; currency union; GDP;