Central bank issues stimulus warning

TORONTO, VANCOUVER -- The Bank of Canada has issued a rare warning to federal and provincial governments that they should not use their windfalls to take actions that would overheat the Canadian economy and provoke inflationary pressure.

The economy is operating at close to capacity, a senior bank official said yesterday, and governments -- some of which are unexpectedly flush with cash this year -- need to keep this in mind when making fiscal decisions.

"Economic outcomes are better and adjustments less costly when macroeconomic policies are working in tandem," senior deputy governor Paul Jenkins said in a speech to the Vancouver Board of Trade.

"In this regard, given the current strength of domestic demand in Canada and the high level of resource utilization, governments need to guard against adding to any excess demand pressures."

However, Mr. Jenkins declined to say what measures the federal government should avoid -- in terms of tax cuts or spending -- to make sure the economy remains on an even keel.

"This is certainly not a comment on any measure that a government might or might not take," he told reporters after the speech. "It is really a point that says from an economic perspective we have an economy that is running very close to production capacity and we all need to be aware of that."

While the Bank of Canada's comments are too late to sway much in terms of government spending and taxation policy this fiscal year, governments are now gearing up for next year's budgets. As well, elections are pending in Ontario, and possibly Quebec and at the federal level as well -- which usually mean higher levels of spending.

"It's more of a warning into next year's budget season," said Douglas Porter, deputy chief economist at BMO Nesbitt Burns.

The central bank probably wants to avoid a repeat of the 1980s, when monetary policy was trying to slow down the economy but governments, especially Ontario, were spending money as fast as it came in, he said.

"It's a preliminary shot," said Peter Dungan, economics professor at the University of Toronto. "It reinforces the idea that we are close to capacity, so don't rock the boat."

The central bank has held its key interest rate steady since May, saying inflation is under control for now and the economy is chugging along at a healthy pace. But poorly planned government decisions could cause consumer prices to shoot up, he warned. "Adding to excess demand pressure would certainly add more pressure to inflation," he said in an interview with Report on Business Television.

Government spending and tax cuts boosted disposable income in Canada significantly during the first half. Rebates from the Alberta government and federal income tax cuts that reached Canadians' pocket books in their tax returns in the spring may have injected up to $4-billion into consumers' wallets, researchers at U of T say.

Fiscal stimulus has continued in the third quarter too. The cut to the federal goods and services tax came into effect on July 1, as did the federal Universal Childcare Benefit, which gives families $100 per month for each child under 6.

On the spending side, some governments, notably Ottawa and Ontario, are generally more flush with cash than they had budgeted for this fiscal year. Spending by all governments in Canada is expected to rise by 4 per cent this year (not including inflation), and 4.4 per cent in both 2007 and 2008, according to the U of T forecast. Those rates are considered quite stimulative.

Plus, Ottawa said yesterday it will dole out $4.4-billion to softwood lumber producers before the end of November -- although most of that money will likely end up as corporate investment rather than disposable income.

However, there are few other stimulative measures in the hopper for this year, and it would take a major government spending or tax initiative to spill over into wages and consumer prices, Mr. Dungan said.

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Provincial surpluses 2005-06

Alberta $10-billion

Ontario $299-million

B.C. $3.1-billion

Saskatchewan $102-million

Manitoba $3-million

Quebec $74-million

New Brunswick $22-million

Nova Scotia $72-million

PEI ($13-million)

Nfld. and Lab. $6-million

SOURCE: PROVINCIAL REPORTS, BMO NESBITT BURNS