Stimulus Material

By mid-2023, macroeconomic challenges renewed the debate over fiscal policy, government borrowing, and the consequences of a growing national debt. A slowdown in global aggregate demand, coupled with persistent supply-side bottlenecks, had left several developed economies operating below full capacity. Despite rising interest rates, corporate investment in some regions failed to fully absorb domestic savings, raising concerns of a 'saving glut' that could drag down growth. Fig. 1 outlines the potential transmission channels between high household savings, capital accumulation, and long-term output.

However, if elevated domestic savings are not actively channelled into productive physical or human capital, they risk depressing aggregate demand. In some advanced economies, this accumulation of idle savings is closely linked to widening wealth inequality. Fig. 2 illustrates the relationship between Gini coefficients and average GDP growth rates across selected OECD nations.

In Canada, weak domestic demand helped temper some of the post-pandemic inflationary pressures. Between April 2022 and April 2023, Canada's Consumer Price Index (CPI) rose from 149.8 to 156.4. Central banks often seek to anchor such price movements by setting explicit inflation targets, which helps stabilize expectations among wage-negotiators, businesses, and investors. However, maintaining the credibility of an inflation target is highly challenging in the face of volatile energy prices and agricultural supply shocks. Should a central bank repeatedly miss its target, public confidence in monetary policy can quickly erode, complicating future stabilization efforts.

Many emerging market governments also adjust their monetary frameworks to cope with structural shifts. For instance, the central bank of Colombia historically maintained an inflation target of 3.0% with a tolerance margin of plus or minus 1 percentage point. To accommodate external pressures, some nations have periodically widened their target bands or adjusted their midpoints. Fig. 3 displays Colombia's inflation outcomes against its official target bands over the 15-year period.

At the start of 2023, Canada's modest recovery was accompanied by a persistent negative output gap. Economists debated whether a surge in public investment, funded by government debt, could stimulate growth and close the gap. However, expanding fiscal deficits inevitably increases the national debt. In early 2023, Canada's net national debt stood at approximately 83% of GDP. Critics argue that higher government borrowing risks sparking inflation, depending heavily on whether the debt is monetized or purchased by domestic and international savers. There is also a risk of 'crowding out' if the government struggles to find willing buyers for its sovereign bonds at reasonable yields. In contrast, Japan, with a national debt exceeding 260% of GDP at the same date, continued to issue sovereign debt at exceptionally low yields without facing a shortage of willing lenders.