Provincial solvency and federal obligations

Summary: Provides a number of important lessons for Canadian fiscal policy authorities at the federal, provincial and territorial levels. The analysis suggests that the combination of future economic conditions, featuring more modest output increases than historically, and "status quo" policies, in particular the continuation of fairly rapid growth in health care spending, will put a number of provinces into debt positions that could lead to defaults. Interestingly, Alberta, despite its current net asset position, has the highest longer-term default probability. If credit rating agencies and markets share the perspectives from this report's analysis, then in theory the provinces should be facing higher interest rate spreads over federal rates. The author surmises that the relatively low spreads observable vis-a-vis federal rates are due to the assumption that the federal government will bail out any defaulting provincial government, as was done on several occasions in the 1930s. The complex analysis leading to this conclusion leaves a lot of room for question. Perhaps the agencies and markets believe provinces will act more responsibly to correct soaring debt than implied by the report's mechanical extrapolations. Perhaps they don't accept the study's definition of what debt burdens lead to high default risk. Nonetheless, the study does bring to our attention a number of very important issues that are highly relevant to current and future fiscal policy in Canada.