A lot has been written, as it turns out, on Canada's experience with fiscal discipline in the mid-1990s. In 1993, Jean Chretien's Liberals were elected with a majority government and, with their February 1995 budget, embarked on a period of fiscal tightening. The change in policy was a response to a long period of federal budget deficits, and accumulating federal debt, which you can see in the following charts. The first shows the Canadian federal government surplus as a percentage of GDP, and the second shows the U.S. and Canadian federal government debt/GDP ratios. 1995 Jackson Hole conference. His program focused primarily on spending cuts, particularly reductions in corporate subsidies, and reforms to unemployment insurance and federal transfers to the provinces. As well, the original budget proposed a 15% cut in federal public employment.
You can see the results in the above charts. Martin was even more successful in reducing federal deficits than he expected, and the Canadian government ran surpluses, on average, from the late 1990s until the 2008-09 recession. As well, the debt/GDP ratio fell from a high of close to 80% to about 40% before the Great Recession. Further, government expenditures on goods and services (all levels of government) fell significantly, as a fraction of GDP:
So, given those kinds of fiscal cutbacks, maybe you're thinking that we should have seen a contraction in aggregate economic activity in Canada. But that didn't happen. Here's what the time series of real GDP in the U.S. and Canada (normalized to 100 in 1995Q1) look like: celebrated on the right. But left-leaning types aren't quite so happy about it. Canadian electors didn't seem to have a problem with it though. Chretien's Liberals were re-elected with a majority government in 1997, and again in 2000.
Of course, the basic outline from the above four charts doesn't give us that much to go on. We know there could have been a lot going on at the time in Canada, other than changes in fiscal policy. For example, suppose you are a textbook Keynesian, and you read this piece on the Cato Institute's web site. So what, you might say. Maybe those Canadians cut spending when cyclical conditions were very favorable - we know that Keynesian economics only applies to periods of slack. That's roughly what Stephen Gordon had in mind in this post. So, we might look more closely at Canadian labor market data for this period. Here's the labor force participation rate, the employment/population ratio, and the unemployment rate: in this blog post. This only looks like a recovery "well under way" (as Gordon puts it) if you're looking at it with hindsight. In February 1995 it wouldn't have looked so great. There had been a persistent decrease in the employment/population ratio and in the labor force participation rate beginning about 1990, and the unemployment rate stood at 9.6% - below its peak but still quite high. It was pretty common for people to observe those features in the post-Great Recession U.S., and call that labor market slack. So, if you are a textbook Keynesian, those observations would have to puzzle you. How can we radically cut the size of government in a slump and not see signs of big fiscal multipliers and disastrous aggregate performance?
But, not so fast. Maybe monetary policy is helping things along? Indeed, in some discussions of the Greek crisis, people have suggested that Greece could have solved its problems in a more straightforward way if it were not tied to the Euro. A country with an unsustainable deficit has to correct that problem, but it's easier to do that if devaluation is an option. This has two effects, according to this logic. First, we can now pay back our debt to foreign creditors in devalued currency - we have implicitly defaulted on part of our debt, and have avoided the costliness of negotiating with nasty Germans and being thrown out of office by a grumpy electorate. Second, assuming sticky prices, our exports are now cheaper and our imports more expensive. Therefore, as long as the Marshall-Lerner condition holds, there should be an increase in net exports - i.e. a boost in Keynesian aggregate demand.
Indeed, during the 1990s, Canada experienced a depreciation in its exchange rate with the U.S. dollar, and a large increase in net exports:
What was going on with monetary policy? One standard approach might be to look at short-term overnight interest rates. Here's the fed funds rate and the overnight interest rate in Canada, which is what the Bank of Canada targets day-to-day:
What are we to conclude from this? Post-1990 Canada certainly looks like a country with successfully managed fiscal and monetary policy. The federal government brought fiscal policy under control and reduced the burden of government debt, and the central bank adhered to its announced inflation target. How did they do it? In the 1995 federal budget, some well-liked social programs, including government health care, remained more or less intact, and cuts were made in a politically palatable way. Of course, it didn't hurt that the U.S. economy was booming at the time. Are there lessons that we can translate to Greece in the current era? Only the obvious I think. Political stability and good government are important.