Will $52.9B in new federal spending make inflation worse?

Heading into this week's federal budget, one question loomed large: would new spending fuel inflation and make it harder for the Bank of Canada to start cutting interest rates?

The budget lays out plans to spend nearly half a trillion dollars in taxpayer money. The new spending in the document is modest by comparison$52.9 billion. But it's still new money being poured into an economy fighting to get inflation back under control.

Economists say the spending announced this week in Ottawa won't necessarily change the forecast that assumes the year-over-year rate of inflation will come down to 2.5 per cent by the end of this year, and all the way to the 2 per cent target by the end of 2025.

"But spending is spending," Desjardins chief economist Jimmy Jean told CBC News.

While spending money now on new housing will bring down shelter inflation in the years to come,he said, "in the meantime, you have to hire workers and get more materials and that can create more pressure on inflation."

The shadow cast by inflation isn't confined to how much new spending might drive price growth.

The bigger issue here is how much the budget depends oninflation working its way back to target in relatively short order.

"It all depends on continued growth," said Sahir Khan, executive vice president of the Institute of Fiscal Studies and Democracy at the University of Ottawa.

That growth depends on the economy getting better. The economy getting better depends on interest rates falling this year. And that, in turn,depends on inflation steadily working its way back to the two per cent target.

A budget built on optimism

Those factors aren't merely driving the economics of the budget. Khan said they're driving the politics as well.

"It all has to line up in terms of the growth. You have to have enough rate cuts ahead of the next election to make people feel better as they head to the voting booth, and that's a lot of dependency," he said.

WATCH |CBC News breaks down the biggest items in the new federal budget:

What's in the new federal budget?

2 months ago

Duration 3:18

CBC News breaks down the biggest items in the new federal budget and how the government is planning to pay for billions in new spending.

For an example of just how fragile that chain of events can be, look no further than the re-acceleration of inflation in the United States.

The year-over-year rate of inflation there has jumped back up to 3.5 per cent. In response, American policymakers are now talking about leaving interest rates higher for longer.

"The recent data have clearly not given us greater confidence and instead indicate that is likely to take longer than expected to achieve that confidence," said Jerome Powell, chair of the Federal Reserve,the U.S. central bank.

Canada's economic forecast has been clouded by uncertainty for years now.

First it was the pandemic and the impact of lockdowns. Then it was supply chain shocks and the sudden spike in price growth, which was followed by one of the fastest and most aggressivecycles of interest rate hikesin history.

The Canadian economy grew quite a bit more than it was forecast toin the Fall Economic Statement released last November. That gave the government billions of dollars inextra wiggle room.

Jean said much of that growth came from increased immigration. But now the federal government has curtailed the number of new Canadians that will arrive next year. Jean points out thatthe forecasts used in the federal budget were compiled before the immigration targets were changed.

"The only reason we didn't have a recession in Canada in 2023 was immigration," he said. "Now we've cut back on that big time, so it's going to become a headwind and those estimates don't account for that."

He said that's just one example of a factor that could shift predicted economic growth.

Khan said this budget hasn't left itself a lot of room for error.

"There's actually no prudence in here. There's an assumption of no economic headwinds, no risk on the horizon," he said. "We don't have the dry powder we used to have."

That's all fine as long as the economic numbers come in as expected. But if we've learned anything over these past few tumultuous years, it's that the numbers have a tendency to surprise us.