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The National Debt is the overall debt of the federal government – the difference between the federal government’s liabilities (mostly outstanding bonds) and its “net recorded assets” (mostly those assets which yield interest, profits or dividends). Thus it measures, on balance, how much the federal government owes to creditors.

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While it is true that the net federal government debt rose from about $3 billion in 1939 to over $22 billion by 1975. In practice, it is common for budget deficits to be financed by a combination of borrowing and “printing,” a practice that can be economically beneficial as long as the “printing” of money is kept within reasonable limits.

Part B: The National Debt

We have seen that the use of government fiscal policy to stimulate the economy during recessions requires that the government borrow money (mostly through bond issues) in order to finance its budget deficits. The total amount of federal government debt thus incurred – the amount of money owed by the federal government – is called the “National Debt.” By 1983 the National Debt will amount to over $100 billion, or nearly $4000 for every man, woman, and child in Canada.

The National Debt has, over the years, been the subject of a great deal of misunderstandings, fears, myths and political hypocrisy. Many Canadians believe, for instance, that the National Debt is owed to other countries and that Canada may go bankrupt because of it. Both of these are myths. On the other hand, few Canadians appreciate the real dangers concerning the National Debt. We will examine first the myths, then the real dangers.

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This concern is often expressed in the words that “any business that ran that way would go broke.” Sometimes the reference is to government inefficiencies and waste, which no one condones, but often the reference is to budget deficits and the rising National Debt. However, the matter is not that simple. Most successful businesses accumulate not only productive assets but also more and more liabilities, or debt, reflecting the money that was borrowed to finance those assets. Businesses do not regard such a situation as bad management; indeed, the acquisition of the assets can be financially beneficial to the company by increasing its profitability.

Just as a growing economy requires more private productive assets, such as factories and equipment, it requires more social assets, such as roads, hospitals and schools. Both private and social assets are typically financed by borrowing, so that the debts of businesses and governments (as well as households) have risen. The simple fact that these debts have risen in no way proves mismanagement on the part of governments or businesses or households in general.

Another problem that contributes to misunderstandings concerning government deficits is that many people confuse a government budget deficit with business “loss.” Some types of government budgets lump together all spending – for “current” purposes such as payroll and “capital” purposes such as airports – so that, whenever social assets are bought or built, the government’s budget shows an excess of spending over the current year’s tax revenues, or a deficit. By contrast, a business’ income statement does not include “capital” expenditures, on items such as plant, as current expenses, and its balance sheet shows its assets as well as its liabilities (or debt). Governments’ budgets generally show the liabilities without showing the corresponding assets.

Furthermore, no business has the responsibility to prevent recessions in the economy, and deficit spending – financed by borrowing – is a proven method of fulfilling that responsibility. Rising unemployment gives the government the choice of either ignoring the problem or using deficit spending to combat it. Considering that the government is responsible for maintaining “full employment,” it could well be argued that good management sometimes requires the government to have budget deficits.

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Not necessarily. Most households are in debt, or their cars, appliances, houses, credit card purchases, and so on. And practically every business in the country is in debt, to pay for inventories, equipment and facilities. As consumers and businesses have found, debt can be very useful if it is properly managed. As with debt in general, the dangers associated with the National Debt lie not with debt itself, but rather with excessive debt, as we will see.

Public opinion often tends to judge any deficit as evidence of economic trouble and sometimes as a firm proof of fiscal irresponsibility. Government deficits are inherently neither bad nor good. What matters about deficits is their impact on people.

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The vast majority of the National Debt is owed to Canadians – those individual Canadians and Canadian financial institutions such as banks, insurance companies, trust companies and pension funds who have bought the government bonds. Many people believe that the National Debt is owed to other countries, so that it represents a claim by foreign creditors on our economy, a claim that could cause Canada to go “bankrupt.” This belief is incorrect, because generally, less than 4 percent of Canada’s National Debt has been owed to foreign creditors.

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This is a good question – how can deficits, which increase aggregate demand, contribute to economic stagnation? The problem concerning stagnation arises not on the demand side of the economy, but rather on the supply side. If large government budget deficits are financed by heavy borrowing by government, in competition with business borrowing, the result can be depressed capital investment by business.

Business investment spending could be depressed for two reasons. First, the excess demand for the limited volume of savings could drive interest considered appropriate to borrow to buy them and repay the loan in the future.

Another reason for federal government borrowing is to finance budget deficits to combat recessions. Thus, the federal government’s responsibility for minimizing the effects of recessions sometimes requires it to go into debt. Historically, another major reason for government borrowing and increases in the National Debt has been the financing of wartime expenditures. For example, the Second World War added over $10,000,000,000 to Canada’s National Debt.

Each of the above is generally considered to be a legitimate reason for borrowing by the government. However, ordinary operating expenses of the government, such as its payroll, should be paid for by tax revenues. It is not considered to be good financial practice to borrow (or even worse, print) money to cover operating expenses, or to avoid a necessary increase in taxes for political reasons, any more than it is considered appropriate for households to go into debt to pay their telephone or food bills.

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That depends largely on how the budget deficits are financed. If they are financed by printing money, there is a real danger that rapid increases in the volume of money in circulation (the “money supply”) will cause rapid inflation. This is the most obvious danger in excessive budget deficits, and the one with which most observers are familiar. However, there is another, more subtle, danger in excessive budget deficits: they can also contribute to slow economic growth, or economic “stagnation.”

The Perils of Budget Deficits

Budget deficits can be likened to drinking liquor, in that if they are properly timed and used in appropriate quantities, they will not be harmful and in fact can be beneficial. However, as with liquor, excessive budget deficits can have severe side effects, including a “hangover” of severe inflation accompanied by stagnation, or “stagflation.” And, like a hangover, it can be considerably easier to get into this situation than it is to get out of it.

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If the government were too anxious to stimulate the economy out of a recession, it might use excessively large deficits. This danger tends to be more severe before elections, when the government may be anxious to reduce the unemployment rate quickly before the election. “Another possibility is that government spending may outrun tax revenues (perhaps due to a combination of high government spending and/or unwillingness to increase taxes), causing budget deficits even during an economic boom, when the economy does not need stimulation.

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Unfortunately, the matter does not end here. As we saw in Chapter 10, there are different definitions of “money supply,” ranging from the narrowest (M1), which includes only currency plus demand deposits, to broader definitions such as M2, which includes non-chequing  savings deposits and personal term deposits. These definitions are reviewed in Figure 11-6. Due to the great difference in the sizes of M1 and M2, it is obviously important that the Bank of Canada select the appropriate one as its “target” for its measurement and control of the money supply.

From 1975 to 1982, the Bank of Canada used M1 as its target for monetary policy. In his 1978 Annual Report of the Governor of the Bank of Canada to the Minister of Finance, Gerald Bouey stated that M1 had been chosen because “it moves with the trend of aggregate spending in the economy in a fairly predictable manner and it is susceptible to control by the central bank through the adjustment of short-term interest rates…Our experience to date in using M1 has confirmed in my mind its usefulness as a proximate target in the conduct of monetary policy.” In short, the Bank of Canada regarded M1 as the most relevant measure of the money supply because it includes those most immediately spendable funds (currency plus demand deposits) that have the greatest influence on the level of aggregate demand in the economy, and thus on the performance of the economy.

The Different Sizes of M1 and M2 February 1982

Currency Outside Banks

$10 038

Demand Deposits

- 13 322

Total: Ml

$23 360

Other Chequable Deposits

7138

Total: MiB

30498

Notice and Personal Term Deposits

91074

Total: M2

121 572

FIGURE 11-6 The D of M and M2 February 1982

Millions of  Dollars

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