Canadian Manufacturing

Infrastructure spending, not rate trimming key if economy slows: report

CIBC World Markets report claims nation can't depend on monetary policy should economy falter



Toronto—Increasing government spending on infrastructure instead of trimming interest rates may be Canada’s best path if economic growth falters in the next year, according to a new CIBC report.

The CIBC World Markets Report, Canada’s Plan B, claims the nation can’t depend on monetary policy should the economy slow, instead encouraging stimulus through infrastructure spending.

“Canada’s Plan B can’t depend on monetary policy, given how low rates already are,” CIBC chief economist and report author Avery Shenfeld said in a statement. “If the global picture materially sours, borrowing more, particularly at the federal level, and spending more on infrastructure projects could reduce future deficits and improve growth in the process.”

According to CIBC, the math supporting this approach is illustrated in 30-year government bond rates, which are now below Canada’s long-term economic growth rate.

This means the cost of financing longer-term debt will steadily shrink over time as a share of GDP.

“Infrastructure spending that adds to the economy’s productive capacity will raise tax revenues that will offset the added financing costs,” Shenfeld said.

In other cases, Shenfeld said the equation is much simpler.

“Some projects (like) toll roads (and) power projects generate a direct revenue stream for governments that can more than cover the risk-adjusted financing costs,” he said. “Canada has a number of projects under consideration in the power sector, some of which involve publicly-owned utilities where government funding is part of the plan.

“The dive in interest rates makes those projects look ever more attractive, and getting moving would be even more compelling if slack opens up in the economy.”

Borrowing costs are once again lower than was expected at budget time, according to Shenfeld.

“Today’s tamer rate environment could deliver another $2- to 3-billion of combined interest savings for federal and provincial governments in 2012/13 relative to budget plans,” Shenfeld said. “That position, combined with additional budget buffers like contingencies in spending and reserves for forecast disappointments, creates additional room for governments relative to their spring budgets.”

Shenfeld, however, cautions that the benefits of increased borrowing to fund more infrastructure projects would only be realized if we are facing a longer period of economic slack.

Otherwise the additional building activity might only accelerate the timetable for Bank of Canada rate hikes and crowd out private construction projects.

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