Taken together, the current size of the federal and provincial government debts is fairly large by international standards. Nevertheless, after a 20-year rise in the federal debt–GDP ratio of 50 percentage points, this trend has ended and the debt ratio has been pulled back down by 35 of those 50 percentage points. Questions concerning the extent to which the government should gear current fiscal policy to reinforce this turnaround will dominate debate in the coming years.
Standard measures of the budget deficit are imperfect measures of fiscal policy because they do not correct for the effects of inflation, do not offset changes in government liabilities with changes in government assets, omit some liabilities altogether, and do not correct for the effects of the business cycle.
According to the traditional view of government debt, a debt-financed tax cut stimulates consumer spending and lowers national saving. This increase in consumer spending leads to greater aggregate demand and higher income in the short run, but it leads to a lower capital stock and higher foreign indebtedness, and so to lower income in the long run.
According to the Ricardian view of government debt, a debt-financed tax cut does not stimulate consumer spending because it does not raise consumers’ overall resources—it merely reschedules taxes from the present to the future. The debate between the traditional and Ricardian views of government debt is ultimately a debate over how consumers behave. Are consumers rational or shortsighted? Do they face binding borrowing constraints? Are they economically linked to future generations through altruistic bequests? Economists’ views of government debt hinge on their answers to these questions.
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Most economists oppose a strict rule requiring a balanced budget. A budget deficit can sometimes be justified on the basis of short-run stabilization, tax smoothing, or intergenerational redistribution of the tax burden.
Government debt can potentially have various additional effects. Large government debt or budget deficits may encourage excessively expansionary monetary policy and, therefore, lead to greater inflation. The possibility of running budget deficits may encourage politicians to unduly burden future generations when setting government spending and taxes. A high level of government debt may risk capital flight and diminish a nation’s influence around the world. Economists differ in which of these effects they consider most important.