How to fund increased defence spending? There’s nothing wrong with borrowing

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Guio Jacinto is a political economist and the economic and trade policy analyst with the United Steelworkers.

The federal government’s plan to raise defence spending to 5 per cent of GDP by 2035 has reignited debate over how it should be funded. Predictably, the right urges prioritizing national security over social programs, implying budget cuts, while the left proposes raising revenue by closing tax loopholes that benefit the wealthy.

The federal government, for its part, does not appear eager to raise taxes. And their proposals to cut public expenditures – by reducing the size of the public service – are unlikely to generate sufficient savings.

That leaves borrowing. Canada’s federal debt-to-GDP stands at 40 per cent – or 33 per cent excluding debt owed to itself – one of the lowest levels in the G7. The first-quarter 2025 deficit was just 1.2 per cent of GDP, compared with a projected 6 per cent in the United States, while recent rate cuts in Canada will lower the cost of new borrowing.

Despite concerns from some, Canada’s fiscal position remains strong. However, borrowing from wealthy rentiers exacerbates inequality. For some, like hedge fund manager Warren Mosler, interest payments on government debt are like a basic income scheme for the rich. He’s not wrong.

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There is another option: the federal government could “borrow” from itself by having the Bank of Canada purchase its debt securities. This approach, known as overt monetary financing – often mislabeled as “printing money” – offers an alternative.

Canada can pursue this route because it has a high degree of monetary sovereignty: it issues a non-convertible fiat currency which is backed by its power to tax, has very little foreign currency debt, and its currency is free to float on forex markets. Unlike households or provinces, the federal government is not revenue-constrained in the traditional sense because its Crown corporations – the Bank of Canada and the Royal Canadian Mint – issue the currency.

While overt monetary financing is often criticized as inflationary and dangerous, Canadian economic policy history tells a different story.

As economist Josh Ryan-Collins documents in Is Monetary Financing Inflationary? A Case Study of the Canadian Economy 1935-75, Canada made extensive use of overt monetary financing to support public investment and national development. Between 1935 and 1939, the Bank of Canada funded over two-thirds of federal spending, contributing to a 77-per-cent increase in Gross National Product and spurring private investment. This spending not only helped pull Canada out of the Depression, it also created key nation-building institutions, such as the CBC, the NFB and Trans-Canada Airlines, now Air Canada, to reduce U.S. influence over our culture and airspace.

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This practice of supporting government spending continued during the Second World War, when the central bank purchased more than $500-million in government securities directly and provided liquidity to private banks to purchase government debt.

In the postwar period, the Bank of Canada financed the creation of the Industrial Development Bank (now the Business Development Bank of Canada) to support small and medium-sized businesses. Over 31 years, the IDB authorized 65,000 loans totalling $3-billion, with a 90-per-cent repayment rate. Importantly, the IDB was funded entirely through central bank money creation – demonstrating monetary sovereignty in action.

Crucially, Mr. Ryan-Collins demonstrates that – contra monetarist dogma – this form of financing did not lead to runaway inflation. This is an important insight. Spending – public or private – only becomes inflationary when it exceeds the economy’s real productive capacity. It is resource constraints, not money creation itself, that drive inflation. As Keynes put it, “We can afford what we can do.” Once we understand that the availability of money is not the central limitation, we can turn to the real question: Do we have enough labour, capital, and materials to meet our policy objectives?

As Canada suffers the effects of a trade shock and threats to its sovereignty from the United States, we are once again called to engage in nation-building. In doing so, we should look to our own history.

Despite criticism from contemporary economists, overt monetary financing has a rich and successful legacy in Canada’s economic development. Previous generations of policy makers understood that the currency-issuing powers of the federal government could be used to advance the public interest. If we are serious about securing and building an independent future, we must recapture that understanding and use our monetary sovereignty – not pretend it doesn’t exist.