U.S. budget deficit: What it means for Canada?
The U.S. Treasury Department recently announced that the U.S. government ran a deficit of US$461 billion from October 2015 to March 2016—up almost five per cent from the first half of fiscal 2015. This represents the first increase in the federal budget deficit relative to the size of the U.S. economy since 2009.
The Congressional Budget Office (CBO) projects that the 2016 fiscal year U.S. government deficit will be $544 billion or $105 billion more than the deficit recorded for 2015. Given the CBO’s forecast for U.S. economic growth, the projected 2016 deficit is expected to equal about 2.9 per cent of gross domestic product (GDP). By way of comparison, the federal government’s deficit as a share of GDP peaked at 9.8 per cent in 2009.
The projected deficit over the next few years is expected to grow modestly primarily due to higher Social Security outlays and increased expenditures on health-care programs including subsidies tied to the Affordable Care Act (Obamacare). Nevertheless, given the CBO’s forecast of sustained, albeit moderate, growth over the next few years, the projected government deficit as a share of GDP is expected to remain pretty much unchanged from 2016-2018.
One can question the CBO’s relative optimism about GDP growth and, therefore, the benign forecast of the relative budget deficit over the next few years. Specifically, slower-than-forecast GDP growth and higher interest rates could result in significantly higher ratios of deficits to GDP than the CBO projects; however, it’s the CBO’s longer-run projections that are eye-catching.
In particular, the CBO projects that the cumulative federal government deficit will increase from around US$3.6 trillion over the period 2017-2021 to around US$8.8 trillion over the period 2022-2026. The projected deficits as a share of GDP are correspondingly forecast to increase to 3.4 per cent and 4.5 per cent, respectively, over those two time periods. Again, the main source of growth in the deficit is the projected increase in federal outlays on “mandatory” programs such as Social Security and Medicare. As well, federal government expenditures on interest payments will increase with the growth of outstanding government debt. The total federal government debt is projected to reach 86 per cent of GDP by 2026.
So, what do these projections imply for the U.S. economy and indirectly for the Canadian economy?
One implication is that the continued growth of U.S. government spending and borrowing might crowd out private-sector investment in the U.S. (from Canada and elsewhere), especially if the increased spending and borrowing contribute to higher U.S. interest rates.
A second implication is that the government will take a larger share of the productive resources from the private sector, contributing to slower productivity growth and slower overall growth of the U.S. economy. Slower economic growth in the U.S., in turn, implies lower net Canadian exports to the U.S. market which, other things constant, will contribute to slower economic growth of the Canadian economy. Furthermore, higher U.S. interest rates will put either upward pressure on Canadian interest rates and/or downward pressure on the value of the Canadian dollar.
The outcome of the upcoming presidential and congressional elections could affect the trajectory of federal government expenditures. In particular, if the Democrats retain the presidency and regain a majority in the Senate, the CBO’s spending and deficit projections may prove too modest.
It’s not too early for Canadian policymakers to be aware of the risks that a rapid future increase in U.S. government deficits poses for the Canadian economy.
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