3.7: The Government’s Role in Managing the Economy

The Canadian government, including federal, provincial and municipal governments, plays many roles within the Canadian economic system and influences business activities in many ways. The roles the government plays are as follows:

• Government as a customer
• Government as a competitor
• Government as a regulator—promoting competition, protecting consumers, achieving social goals and protecting the environment
• Government as a taxation agent
• Government as a provider of incentives
• Government as a protector of consumers or customers
• Government as a provider of essential services

Businesses may also influence government through lobbying, joining trade associations, making political donations and trying to convince voters to support or oppose certain regulations and policies.

In managing the economy, the government may use three main policies—monetary policy, fiscal policy, and national debt management.

Monetary Policy

Monetary policy is exercised by the Bank of Canada, which is empowered to take various actions that decrease or increase the money supply and raise or lower short-term interest rates, making it harder or easier to borrow money. As shown in Figure 3.10, when the Bank of Canada believes that inflation is a problem, it will use contractionary policy to decrease the money supply and raise interest rates. When rates are higher, borrowers have to pay more for the money they borrow, and banks are more selective in making loans. Because money is “tighter”—more expensive to borrow—demand for goods and services will go down, and so will prices. In any case, that’s the theory.

The Bank of Canada will typically tighten or decrease the money supply during inflationary periods, making it harder to borrow money.

To counter a recession, the Bank of Canada uses expansionary policy to increase the money supply and reduce interest rates. With lower interest rates, it’s cheaper to borrow money, and banks are more willing to lend it. We then say that money is “easy.” Attractive interest rates encourage businesses to borrow money to expand production and encourage consumers to buy more goods and services. In theory, both sets of actions will help the economy escape or come out of a recession.

Fiscal Policy

Fiscal policy relies on the government’s powers of spending and taxation. Both taxation and government spending can be used to reduce or increase the total supply of money in the economy — the total amount, in other words, that businesses and consumers have to spend.

Below are a few key points:

• Taxation as a tool. The federal government adjusts taxes (e.g., income tax, corporate tax, GST) to influence economic activity. For instance, tax cuts may be implemented to stimulate consumer spending and investment during economic downturns. When the country is in a recession, government policy is typically to increase spending, reduce taxes, or both. Such expansionary actions will put more money in the hands of businesses and consumers, encouraging businesses to expand and consumers to buy more goods and services. Expansionary fiscal policy is used to increase government expenditures and/or decrease taxes, which causes the government’s budget deficit to increase or its budget surplus to decrease. When the economy is experiencing inflation, the opposite policy is adopted: the government will decrease spending or increase taxes, or both. Because such contractionary measures reduce spending by businesses and consumers, prices come down and inflation eases. Contractionary fiscal policy is used to decrease government expenditures and/or increase taxes, which causes the government’s budget deficit to decrease or its budget surplus to increase.
• Government spending. Public expenditures on infrastructure, healthcare, education, and social programs are critical components of fiscal policy. Increased spending during economic slowdowns can boost demand and promote growth, while spending reductions may help curb inflation.
• Budget management. Canada’s fiscal policy balances between deficits and surpluses. During recessions, deficits may increase due to stimulus measures, whereas in economic booms, surpluses help reduce national debt.
• Targeted economic support. Programs like the Canada Child Benefit (CCB) or pandemic relief measures (e.g., CERB) reflect the use of fiscal policy to address specific societal or economic challenges and support vulnerable populations.

The National Debt

The national debt is also referred to as Canada’s public debt. If, in any given year, the government takes in more money (through taxes) than it spends on goods and services (for things such as defence, transportation, and social services), the result is a budget surplus. If, on the other hand, the government spends more than it takes in, we have a budget deficit (which the government pays off by borrowing through the issuance of Treasury bonds). Historically, deficits have occurred much more often than surpluses—typically, the government spends more than it takes in.

Below are a few key facts:

• Federal debt levels. As of the 2023-2024 fiscal year, Canada’s federal net debt has risen to approximately $1.33 trillion, reflecting a significant increase from pre-pandemic levels. This surge includes the impacts of COVID-19 relief measures and ongoing fiscal policies.^[1]
• Combined federal-provincial debt. When combining federal and provincial levels, the total net debt reached approximately $2.18 trillion in 2023/24. The debt-to-GDP ratio for federal and provincial governments collectively has risen from 65.7% in 2019/20 to 76.2% in 2023/24.^[2]
• Debt per capita. On average, each Canadian is responsible for approximately $33,682 in federal debt. Provincial variations exist, with Newfoundland and Labrador having the highest per capita debt at $32,561, followed by Ontario at $27,091.^[3]

Media Attributions

“Figure 3.10: Bank of Canada monetary policy actions” is adapted from Chapter 16 – Money and Banking in Fundamentals of Business, © Florence Daddey and Rachael Newton, licensed under CC BY-NC-SA.

Image Descriptions

Figure 3.10

A flowchart titled “Bank of Canada Monetary Policy Actions” consists of nine boxes in three rows of three. On the far left, the top box is labelled Tools; under “Tools,” an arrow point downwards to “Open Market Operation,” where an arrow points down to “Bank Rate.” Each of these have arrows pointing to the centre column.

The centre column is labelled “Expansionary policy (Stimulate business activity and increase the money supply)” and the left column is labelled “Restrictive policy (Slow down business activity and decrease the money supply).”

Expansionary Policy includes

• On the Open Market Operation level: BUY government securities: These purchases increase bank reserves and their ability to make loans to businesses and consumers.
• On the Bank Rate level: LOWER the bank rate: By increasing the willingness of banks to borrow, more loans to businesses and consumers can be made.

Restrictive Policy includes

• SELL government securities: These sales decrease bank reserves and their ability to make loans to businesses and consumers.
• RAISE the bank rate: By decreasing the willingness of banks to borrow, fewer loans to businesses and consumers can be made.

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