Minority Rules: A Shift in Canada’s Fiscal Landscape?

This system was extended and deepened during the Liberal minority of 1972-74 under Pierre Trudeau. By many measures, some of the most activist governments in the past 40 years were minority governments, particularly when the Liberals ruled and the NDP held the balance of power.

However, these minority governments planted the seeds that blossomed into Canada’s fiscal crunch in the mid-1990s.

Of the eight previous minority governments, five were Liberal, and three were Progressive Conservative (PC). In general, PC minorities lasted a little over 6 months, while Liberal minorities tended to hang on for much more than a year.

Usually, Liberal governments follow minority rule, with majorities on the last three occasions – only John Deifenbaker’s landslide in 1958 bucked that recent trend.

Probably the biggest risk for domestic financial markets from a minority government is on the fiscal side. The primary concern is that the Liberals, who were already beginning to ramp up program spending, will be prodded by NDP demands into opening the spigots further.

Many pundits have suggested that any government under Paul Martin would dare not risk the hard-fought gains in eliminating the budget deficit. However, the bigger concern should be that Ottawa will now usher in costly long-term programs, which could handcuff fiscal flexibility down the road, as well as curtailing any room for tax relief.

The plain fact is that the days of government spending restraint have long since ended, in any event. The deep cutbacks began ebbing after 1997, and real government spending has advanced at a 3.2% annual pace over the past five years, running slightly above GDP growth.

In the initial years after the budget deficit was eliminated, Ottawa held broadly true to its 50-50 rule – 50% of excess revenues went to tax relief and debt reduction, and 50% was aimed at new program spending. It is quite clear that the priorities have since tilted heavily to new spending.

The Liberal election platform included $28 billion of new promises over the next five years, but not a dime for tax cuts. If the government seeks NDP support, these estimates should be viewed as a floor, not a ceiling, for new spending.

The 1972-74 period is typically cited as the closest parallel to today’s situation. Public spending surged in that episode, to put it mildly, spiking at a mind-boggling 20% average annual pace over the three years from FY72 to FY75.

While nominal GDP growth was also very strong through this period, there was still a notable upward lurch in government spending to GDP from the early to the mid-1970s. The common theme from all recent minority governments is that public spending is considerably higher as a share of GDP in their aftermath.

It is true that Ottawa’s budget balance and debt position did not deteriorate noticeably during the tenure of recent minority governments.

However, that likely reflects the fact that economic growth just so happened to be on a roll during many of those episodes, flattering deficit- and debt-to-GDP ratios. However, some of those episodes also locked in large spending commitments, spelling serious trouble for the fiscal landscape when the economy eventually turned sour later on.

Thus, the proper way to judge this minority government is not whether it manages to keep the budget balanced in the next year, or so, but whether it locks in a raft of expensive long-term spending commitments.

We continue to believe that Canada’s still-healthy fiscal position and lower core inflation backdrop will help drive long-term bond yields below U.S. levels over the next year. However, suffice it to say that this has become a riskier call in the face of the federal election results.