Deputy Prime Minister and Minister of Finance Chrystia Freeland walks past members of the media during the Liberal Cabinet retreat in Charlottetown on Aug. 22.Darren Calabrese/The Canadian Press
After the Bank of Canada’s interest rate decision on Sept. 6, Finance Minister Chrystia Freeland took the unusual step of issuing a statement about the announcement.
The decision to hold interest rates steady after 10 increases was a “welcome relief for Canadians,” Ms. Freeland said, disregarding the norm that federal finance ministers don’t comment on central bank decisions. She added that she would use “all the tools” at her disposal “to ensure that interest rates can come down as soon as possible.”
On Thursday, the federal government announced a suite of measures aimed at addressing affordability challenges. This includes a cut in Goods and Services Tax on rental-housing construction; plans to bolster the Competition Bureau’s ability to investigate aggressive pricing and block corporate mergers; and a promise to browbeat grocery chains into lowering prices, with the threat of unspecified “tax measures” if they don’t.
After two years of high inflation and 18 months of rising interest rates, the federal government is stepping up its focus on cost-of-living concerns in the face of relentless attacks by political opponents and the Liberal Party’s slide in opinion polls. Prime Minister Justin Trudeau has also faced a chorus of critics in his own caucus who fear that the government has dropped the ball on affordability issues, especially on the housing file.
Ottawa isn’t alone in its newfound fervour. The premiers of Ontario, British Columbia and Newfoundland and Labrador each wrote to the Bank of Canada ahead of the rate announcement urging it not to raise interest rates. And several provinces followed the federal government’s lead this week, agreeing to cut provincial sales taxes on rental-home construction.
Whether any of this will have an impact on inflation or speed the decline in interest rates – Ms. Freeland’s “number one priority,” according to her statement last week – remains to be seen. The fiscal stances of federal and provincial governments, meaning their mix of spending and taxation policies, are doing nothing to cool aggregate demand in the economy and to curb inflationary pressures, according to the Bank of Canada.
And while economists lauded the GST relief on rental-home construction and the moves to give the Competition Bureau sharper teeth, these are policy measures with long runways; they’re unlikely to impact inflation or change the trajectory of interest rates in the short-to-medium term.
“If the Finance Minister wants to have a big impact, she should know how to do it. You can raise taxes significantly, or you can cut spending significantly,” said Christopher Ragan, an economics professor at McGill University, and director of the Max Bell School of Public Policy.
“Of course there’s pain associated with both of those things, both political and economic. But that is how you take steam out of the economy if you were the Finance Minister, and that’s therefore how you reduce the need for the bank to raise interest rates. Everything else, frankly, is dicking around the edges.”
In some ways, the sudden burst of political activity appears oddly timed. The annual rate of Consumer Price Index inflation has fallen from 8.1 per cent last summer to 3.3 per cent this July, while wage growth is running in the 4- to 5-per-cent range. Most economists and bond traders think the Bank of Canada’s policy rate has now peaked at 5 per cent, the highest level since 2001, although Governor Tiff Macklem has been clear he’s prepared to push rates higher if inflation proves stubborn.
That said, food prices and rents continue to rise quickly, and a growing number of homeowners are feeling the pinch of higher interest rates, as fixed-rate mortgages come up for renewal. Housing affordability measures are at all-time lows, particularly for first-time homebuyers.
Then there’s the politics of it. The federal Liberals are facing an opponent in Conservative Leader Pierre Poilievre who is laser-focused on economic messages. And the government faces an uphill battle convincing people it’s not to blame for squeezing household budgets.
A recent poll by Abacus Data found that 41 per cent of Canadians think, incorrectly, the federal government has control over interest rates, either directly or by issuing orders to the Bank of Canada. Meanwhile, 44 per cent think that interest-rate increases are probably not, or definitely not, necessary to reduce inflation. And 40 per cent said it is mostly unacceptable, or completely unacceptable, to reduce economic growth or cause a recession to bring down inflation.
The upshot: A large portion of Canadians across the political spectrum think that the government is directly responsible for pushing up their mortgage payments and making it harder for them to borrow money; and many don’t believe this strategy is necessary or acceptable to bring down inflation.
“From a public engagement, public opinion perspective, inflation is probably the hardest thing that any government deals with,” said David Coletto, chief executive of Abacus Data. “Because there’s so little it can actually do without making it worse. And at the same time, it’s being blamed for the state of how things are.”
Several policies announced on Thursday are a move in the right direction, said Rob Gillezeau, assistant professor of economic analysis and policy at the University of Toronto. Anything that helps the Competition Bureau curb consolidation in Canada’s oligopoly-prone industries is welcome, he said. And the GST relief on rental housing – a policy that the Liberals proposed back in 2015 then abandoned – should, on the margin, increase rental-home construction.
“The GST measure is good. It’s something that everyone knew made sense. But in practice, it’s at least one order of magnitude too small to start getting things back under control” on housing affordability, said Prof. Gillezeau, who was formerly an adviser to the federal NDP and the NDP government in British Columbia.
The Canada Mortgage and Housing Corp. published a new estimate this week that the country needs about 3.5 million additional housing units by 2030 to restore affordability. “You’re going to need a number of measures that are much larger than this if you really want to get housing contained,“ Prof. Gillezeau said.
Then there’s the plan, announced Thursday, to summon grocery chain executives to Ottawa and demand they lower food prices or face an unspecified tax consequence, potentially a windfall profits tax. This type of measure is based on the idea that corporate profiteering is driving inflation: so-called “greedflation.”
Some companies, including Canada’s major grocery chains, have seen profits increase substantially over the past two years. But there’s little evidence that markups – the difference between the production cost of a good or service and its selling price – have been a meaningful source of inflation, according to several papers by Bank of Canada and Statistics Canada researchers, published over the summer. One of the Bank of Canada papers estimates that markup growth accounted for less than one-tenth of inflation in 2021, and that by 2022, when inflation really began to surge, markups were flat or shrinking.
“If you want to bring in the grocery CEOs and whip them with wet noodles, you can do that,” Prof. Ragan said. “But I don’t have very much faith that a public, or quasi-public lashing of the CEOs of grocery stores is going to lead to any change in their pricing behaviour, nor should it.”
When it comes to influencing the path of monetary policy, the federal Finance Minister does have the power to tell the Bank of Canada to lower interest rates, which requires publishing a written directive.
This rule, introduced in the 1960s following the conflict between then prime minister John Diefenbaker and then Bank of Canada governor James Coyne – which led to the latter’s resignation – has never been used. The government does set the central bank’s mandate and inflation target every five years, but leaves it alone to achieve these goals on a day-to-day basis. Economists generally think of a directive from the finance minister as a nuclear option that would prompt the resignation of the central bank governor and send shock waves through Canada’s financial system.
Katherine Cuplinskas, a spokesperson for Ms. Freeland, said that the Finance Minister has no intention of issuing a directive to the Bank of Canada. The “tools” Ms. Freeland is referring to are more garden variety, designed to help inflation move lower and “thus create the conditions for interest rates to ease,” Ms. Cuplinskas said in an e-mail.
“Part of that work is being fiscally responsible,” she said, noting the government’s plan to cut $15-billion from existing spending over the next five years. She also pointed to subsidized daycare, which is designed to increase work force participation by young mothers.
The federal government has been pursuing fiscal consolidation. Its annual deficit has fallen from an unprecedented $328-billion at the height of the COVID-19 pandemic in 2020-21, to a projected $40.1-billion in this year’s budget.
But so far, fiscal policy isn’t acting as a brake on inflation. Government spending, at the federal and provincial levels, is growing at around 2 per cent a year, roughly in line with the Bank of Canada’s estimate of the country’s potential gross domestic product growth. In that sense, government spending is not a key driver of inflation today, but it’s not acting as a counterweight either.
“It’s contributing to the growth of demand in the economy, and in that sense it’s not helping to slow the economy, it’s not helping to relieve those inflationary pressures,” Mr. Macklem said in an appearance last week.
The question of how much government spending drove inflation higher in the first place remains politically charged. Mr. Poilievre puts most of the blame on government spending; hence his frequently used epithet, “Justinflation,” referring to Mr. Trudeau.
Economists are more measured. “Government fiscal policy wasn’t the big driver of inflation, and the proof of that is there are countries that didn’t do a lot of fiscal stimulus that also saw high inflation,” said Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce.
But had federal and provincial governments pulled back on pandemic support-spending once the emergency phase was over, interest rates would likely be lower, Mr. Shenfeld said. “We would have shaved down some of the last few interest-rate hikes, had we taken a more stringent effort at fiscal restraint, either through the spending side or by raising income taxes.”
Going forward, governments can nudge inflation down by cutting spending or raising taxes, said Trevor Tombe, an economics professor at the University of Calgary. But to have a meaningful impact would require much larger changes than anything governments are currently contemplating.
“Based on the papers that I’ve seen … a 10-percentage-point change in government spending relative to the economy is associated with about a one- to two-percentage-point change in inflation,” Prof. Tombe said.
“We have a $2.8-trillion economy. And so to move the needle on CPI through federal expenditure policies alone requires huge changes.”
That leaves the federal government looking for smaller policy tweaks, and hoping that inflation falls quickly. The recent rise in global oil prices doesn’t augur well on this front, with analysts predicting that CPI inflation could move up toward 4 per cent in the coming months. Statistics Canada will publish its August inflation report next Tuesday.