Inflation causing price rising up, overvalued stock or funds, consumer purchasing power reducing concept, air balloon tied with product price tag flying high rising up in the sky.
Nuthawut Somsuk

The battle against inflation has so far been the sole domain of the Bank of Canada, but a new report says fiscal policy should be recruited into the fight.

The report from CIBC World Markets Inc. said that “deeper fiscal belt tightening” could help ease inflation and have “side benefits for the country that we won’t see by letting monetary policy fly solo.”

But fiscal policy has been leaning against the central bank’s efforts. In the first quarter, government spending was still boosting growth, even as the Bank of Canada was trying to cool the economy, the report said.

At the same time, government hiring has outpaced private sector employment, keeping the pressure on labour markets at a time when the prospect of wage inflation remains a key concern for the central bank, it said.

Meanwhile, government benefits are still propping up household incomes more than they did before the pandemic.

Leaving the job of fighting inflation solely to the Bank of Canada has downsides, the report argued.

“One negative of an exclusive reliance on higher interest rates is that it puts housing construction at the centre of the resulting economic slowdown,” the report said. “That’s hardly ideal in an environment in which a shortage of housing is pressuring apartment rents and the overall cost of home ownership.”

Additionally, high household debt creates a risk that monetary policy will end up overshooting and weighing too heavily on the economy as the lagged effects of higher rates work their way through.

“Mortgage renewals for Canadians in 2024 and 2025 could be a significant risk to household financial stability if the Bank of Canada hasn’t sufficiently eased policy by then,” the report said. “A somewhat tighter fiscal path would give the central bank more elbow room to start that process.”

At the same time, tighter fiscal policy could free up government funds for debt reduction, which would help offset some of the impact of higher rates on future government finances, it said.

“In this case, we’re missing an opportunity to do more to reverse the debt/GDP build up from the pandemic without paying any economic price,” it said.

Moreover, a mix of tighter monetary and fiscal policy would reduce pressure on corporate capital spending, allowing more room for companies to make productivity-enhancing investments, CIBC said.

“Improving productivity is a friendlier route to lowering inflation, by reducing business costs, and allowing corporate Canada to ease up on its demand for currently scarce labour by substituting more mechanization,” it said.

While governments are providing capital spending subsidies in certain “green” industries, “a policy mix that was tougher on fiscal policy, and easier on interest rates, would provide a broader improvement in the capital spending backdrop,” the report said.