This article (with a different title) was published in the Globe and Mail on March 6, 2025

Federal and provincial governments plan to introduce pandemic-style measures to support businesses and workers if the U.S. administration carries out its tariff threats. Experience with past recessions suggests there is a risk this support may come too late – especially without Parliament sitting – be excessive and politically difficult to wind down afterward. All of that would hinder fiscal sustainability and the economic adjustment to a new world with tariffs.

If we look at the COVID-19 pandemic, governments scrambled to find ways to quickly provide adequate support, and some people received more in benefits than their previous wage, for longer than warranted. This contributed to fuelling inflation and shortages when the economy reopened. Governments also used COVID as an excuse to do some questionable spending.

This is not too surprising. Fiscal action taken to stimulate the economy in recessions has generally been poorly targeted, untimely, difficult to unwind and has ratcheted uppublic debt. Excessive fiscal support in the recession of 1980s and 90s largely explains the mid-1990s fiscal crisis. The federal debt-to-GDP ratio is not expected to return to its pre-COVID level much before 2040.

This is why economists generally recommended leaving the job of stabilizing the economy to monetary policy, with fiscal policy confined to setting favourable conditions for long-term growth. But the 2008 financial crisis showed the excessive use of monetary policy could be destabilizing, and that fiscal policy could be very effective in stimulating the economy, especially when interest rates are around zero. This created a fiscal policy activism renaissance.

The underlying problems of countercyclical fiscal policies have not disappeared, and excessive fiscal stimuli put in place to combat a tariff-driven recession could hinder economic adjustment and damage fiscal sustainability. This is especially the case if tariffs persist as the pressure to keep support going for too long would be high.

Relying solely on monetary policy would not be appropriate as lower interest rates would encourage personal indebtedness, which poses financial stability risk. The impact of monetary policy changes is seen only six to eight quarters later, so not really timely, and as the Governor of the Bank of Canada recently noted, central banks can do little to mitigate the damage caused by a trade war.

There is a potential solution to this problem: stronger automatic fiscal stabilizers. Automatic fiscal stabilizers are fiscal measures that are automatically triggered by an economic downturn. Employment Insurance is a good example. Those benefits increase when the unemployment rate in a region goes up and automatically decrease when it goes back down.

The progressivity of our tax system is another one. The average tax rate drops as income declines and increases as income rises. But existing stabilizers are not sufficiently generous to deal with large recessions, so they currently require additional monetary and ad-hoc fiscal support, which come with the host of problems outlined above.

There are various ways we can strengthen our automatic fiscal stabilizers. One could be to make the generosity of EI benefits depend on the national unemployment rate. For example, if the average unemployment rate rose by more than a predetermined threshold, the income replacement rate could increase from 55 per cent to 80 per cent, and the maximum insurable earnings could increase from $65,700 to $100,000 for a defined time period.

This scenario could also automatically trigger a one-time doubling of the GST/HST tax credit or Canada Child Benefit. Many other fiscal policy tools could be set up to operate according to state-of-the-economy-based triggers. There would be no need for lengthy debates in Parliament to introduce and unwind, limiting “small p” political pressures.

There are drawbacks, but they could be mitigated. Rule-driven fiscal policies remove the government’s flexibility to tailor support to recession-specific characteristics. Rule-driven support could also be triggered unwarrantedly. However, calling Parliament to vote on new, ad-hoc fiscal policies or stopping benefits from being rolled out are always options.

In the same way that monetary policy has become more rule-driven over recent decades, greater reliance on automatic stabilizers, as opposed to discretionary fiscal policy, would make fiscal policy more systematic. This inturn would instill greater confidence that support will be readily deployed when it is needed most and in a more fiscally sustainable manner.

Before the pandemic, there were calls to strengthen automatic stabilizers before the next big shock hit, but nothing was done. It may be challenging to fully ramp up automatic stabilizers before some tariffs are imposed, but the current context provides both a strong incentive and a good opportunity to move in that direction.