Federal budget’s affordability measures could risk fuelling inflation: Economists

The federal government will reportedly roll out a grocery rebate as part of a slate of measures in the budget aimed at helping low-income Canadians with the cost of living. REUTERS/Blair Gable

The federal government needs to walk a fine line in rolling out a slate of new measures aimed at helping Canadians deal with the surging cost of living, without further fuelling inflation and risk keeping interest rates higher for longer.

The budget, to be tabled in the House of Commons Tuesday, will contain a so-called grocery rebate aimed at low-income Canadians that will be linked to the GST credit, CBC News has reported, citing a senior government source.

The one-time rebate will not be based on grocery receipts or have to be spent on groceries specifically, the CBC source said.

Ottawa has to balance their priorities carefully at this stageRobert Kavcic, BMO Capital Markets

The budget will reportedly also raise the amount students can withdraw from Registered Education Savings Plans for post-secondary schooling and, as first reported by the Canadian Press, the budget will crack down on hidden “junk fees” that inflate the cost of products or services.

While these measures would be intended to help with the soaring cost of living, new government spending could risk propping up consumer demand and therefore prices, economists say.

A balancing act to avoid fuelling inflation

“Ottawa has to balance their priorities carefully at this stage,” Robert Kavcic, senior economist at BMO Capital Markets, told Yahoo Finance Canada.

“Keeping in mind that direct fiscal support was part of the reason inflation broke out in the first place, and not just in Canada, further direct payments to households would only prolong the Bank of Canada’s inflation fight, and leave interest rates higher than they otherwise would be, for longer.”

Kavcic adds there’s no doubt some additional support is warranted, “but those measures should be highly targeted.”

Finance Minister Chrystia Freeland, who is also Deputy Prime Minister, is widely expected to announce additional measures such as possibly extending the GST tax credit, which was temporarily doubled last year, a possible extension of the Canada Housing Benefit and an expansion to the Canada Dental Benefit.

Randall Bartlett, senior director of Canadian economics at Desjardins, says the feds have likely formulated the measures while keeping the potential impact on inflation in mind.

“They’re subject to significant criticism, both from the House of Commons and the broader economic community, in terms of the negative implications of their spending on inflation by exacerbating it, and therefore making the Bank of Canada’s job that much harder and keeping rates that much higher for longer,” he said in a phone interview.

By Bartlett’s estimates, a six-month extension of the GST rebate alone would impact inflation by a meagre tenth of a percentage point.

He says the government needs to stick with “time limited and targeted” measures in the budget.

The federal government announced the temporary increase to the GST tax credit late last year. THE CANADIAN PRESS/Nick Iwanyshyn

During the pandemic, the federal government rolled out generous income measures that, along with a prolonged period of supply chain issues, led to a demand-supply imbalance that put severe upward pressure on inflation. In response, the Bank of Canada aggressively hiked its benchmark rate.

Since then, high inflation and interest rates have hammered household budgets. A recent Angus Reid poll found inflation topped respondents’ list of top priorities for Canada, significantly outpacing other issues like housing affordability and the economy.

Affordability measures already built in, but optics an issue

There are a few factors working in Freeland’s favour though, according to Ian Lee, associate professor at Carleton University’s Sprott School of Business.

He argues there’s substantial support systems already built into Canada’s economy, as evidenced by the higher baseline of federal spending now compared to pre-pandemic.

“When you look at the actual data, we have a very highly progressive income tax system. And there’s a great deal of redistribution of income going on, of which there’s strong support. I think the risk is greater on the inflation side because they’re pumping so much money into the system, and at a time when they’re trying to cool the economy,” Lee says.

The federal government is also not going at this alone, as the provinces have rolled out their own affordability policies, lessening the burden on Ottawa.

BMO’s Kavcic says the provinces have provided roughly $11 billion in direct support to households over the past year, which are inherently inflationary.

However, there’s also the issue of optics in this federal budget and the desire to be seen doing more to help Canadians, Lee says.

“I realize the optics require, and the House of Commons require, that they be seen to be making new announcements, but I think she’s been talking about making sure that they’re not contributing to inflation. I think that is the balancing act. Whether or not they’re able to achieve it is yet to be seen,” Lee says.

Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.

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