So what does Jim Flaherty do now about the economy?

Economic turmoil has the finance minister under pressure to take action

So what do we do now?

Chris Wattie/Reuters

Economic necessity made Jim Flaherty a big-spending finance minister, but he takes pains not to talk like one. Back in August—with the Greek debt crisis escalating and U.S. political gridlock on budget policy frightening investors everywhere—Flaherty was pressed by NDP finance critic Peggy Nash to consider pumping some federal cash into the vulnerable Canadian economy. “That actually is the problem—too much spending,” he told her at the House finance committee. “It’s exactly what we should not do.”

A few weeks later, heading to Marseille, France, for an anxious meeting of the G7 finance ministers, Flaherty was again asked about proposals for governments to ease off on deficit reduction. In the face of a deteriorating global economic outlook, the classic policy response would be an injection of stimulus. But Flaherty recoiled at the notion. “We want to stay the course,” he said.

The steady-as-she-goes message, though, didn’t stop unease from deepening. That prompted Flaherty, Prime Minister Stephen Harper and Bank of Canada governor Mark Carney to hold a rare photo op meeting to show they were on the case. And Flaherty noticeably softened his previously hard-edged anti-stimulus, pro-deficit-cutting rhetoric. “If we get a shock from outside our country,” he told reporters recently, “we’ll have to be responsive, and we’ll be flexible and pragmatic.” The substantial wiggle room implicit in those words served as a reminder of how abruptly Flaherty shifted, in late 2008 and early 2009, from predicting no recession and no deficits, to having to acknowledge a punishing recession and preside over unprecedented deficit spending to combat it.

Private sector economists don’t expect Flaherty to be forced to repeat that dramatic reversal. While a recession is clearly possible, most forecasters still expect Canada to post modest growth this year and next. Still, nobody doubts Flaherty is considering options. Betting among veteran observers from banks and think tanks is that he will lean this time toward selective tax breaks and other measures designed to encourage companies to hire and invest, rather than another big round of direct spending.

The memory of Flaherty’s 2008-2009 about-face casts a long shadow over the decisions he faces this fall and leading into his 2012 budget. He justified the plunge into red ink then by adopting a resolute plan to rebalance the books in short order. Last year’s budget pledged to wipe out Ottawa’s deficit by 2014-15. Flaherty and Harper even exported their focus on restraint, successfully pushing at the G20’s Toronto summit last year for a declaration that industrialized countries would slash their deficits in half within three years. They cast fiscal probity not only as a hallmark of Tory policy in domestic politics but of Canada’s brand internationally.

On the world stage, that branding isn’t in jeopardy. Contrasted against Washington’s chaotic budget process, Ottawa looks like a bastion of sanity. Europe’s ability to solve the Greek debt crisis remains in doubt. In Canada, the apparent danger is merely that the deficit might not be eliminated by 2014-15, as planned, but a year or two later, according to RBC Financial Group chief economist Craig Wright. “We can slip a bit,” Wright says. “It wouldn’t be a self-inflicted wound.”

Still, even if Flaherty can count on markets cutting him some slack, he’s under mounting pressure to look like he’s doing something in the face of a worrying outlook, especially for jobs. His 2009 stimulus gusher fuelled a national building boom, especially in the last two summer construction seasons, but the deadline for finishing projects under the $4-billion infrastructure fund is the end of this month. Instead of looking for ways to replace that waning activity, federal bureaucrats are busy drafting plans for departmental spending cuts of five or 10 per cent, demanded under the Conservatives’ so-called Strategic and Operating Review.

The opposition parties say the time is dead wrong for those cuts. Government insiders, though, say there’s next to no possibility of postponing them. Far more likely is a parallel package of measures to prod the cautious private sector into action. An early taste of the sort of policy Flaherty prefers came this week, with his announcement of a temporary tax credit for small businesses to defray the cost of hiring new employees, a break available to about 525,000 firms with 25 or fewer employees.

A far bigger move is being championed by interim Liberal leader Bob Rae—encourage hiring, and forgo $1.2 billion in federal revenues, by cancelling the scheduled Jan. 1, 2012, increase in Employment Insurance premiums. “If the labour market is deteriorating,” says Wright, “then the EI premium is obviously something they could look to.” That means the next Statistics Canada snapshot of the labour force—September employment figures are slated for release on Oct. 7—will be very closely watched. In August, Canada shed 5,500 jobs, an unwelcome surprise for forecasters who had predicted employment growth.

Along with mulling the EI premium issue, Flaherty is sure to be looking for ways to boost business investment. Last spring, he urged “cash-rich” Canadian companies to “step up to the plate.” Cajoling, though, doesn’t seem to be working. CIBC senior executive vice-president and vice-chairman Jim Prentice—who also happens to be Harper’s former environment minister—last week called for government to get behind billions in energy projects. Prentice cited the federal loan guarantee for Newfoundland’s Lower Churchill River hydroelectric project as “a wise instrument of industrial policy,” and called for governments to “expedite the regulatory and environmental approval processes for megaprojects.”

Encouraging residential construction is another policy option. The Federation of Canadian Municipalities, for instance, is floating ideas such as a federal interest-rate subsidy for builders of moderately priced rental housing, and tax credits for energy-efficiency renovations to rental properties. (The FCM sees plenty of condo building, but a shortage of apartments for rent.) “Looking at something like that,” says FCM president Berry Vrbanovic, “would have the potential of engaging the private sector.”

Those sorts of proposals are likely to get a closer look from Flaherty than any plea for another major round of short-term direct spending. Responsive, flexible and pragmatic he may be, but Flaherty must be hoping to avoid suddenly veering, for a second time in four years, from defending fiscal restraint to embarking on a stimulus spree.

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