Canada |  Increases the risk of stagflation

Canada | Increases the risk of stagflation

With stagnant economic growth and stubbornly high inflation, Canada appears headed for a new period of stagflation, the last episode of which dates back to the 1970s, economists note.

Posted yesterday at 2:43 pm

Brett Bundale
the canadian press

The anomalous combination of rising prices and high unemployment captured the country’s collective imagination some 40 years ago. Supply shocks had spiked energy costs, interest rates had reached devastating levels, and unemployment was rampant.

Today, some experts point out that the conditions are right for a return of this economic phenomenon.

“I would say that next year we are looking at a recession in this country, which, combined with sustained inflation, could translate into stagflation,” says Armine Yalnizyan, an economist and fellow at the Atkinson Foundation.

“We cannot avoid the global forces that point towards recession […], the question is whether rising interest rates will slow down inflation. »

But this return of stagflation could present a milder version of this economic anomaly.

“I don’t think it’s unrealistic to expect a world where inflation and unemployment rise,” said Fred Bergman, senior policy analyst at the Atlantic Provinces Economic Council, an independent Halifax-based think tank.

“We were able to see these two (elements) going up together, which is rare. But it will be very modest compared to what we saw in the 1970s and 1980s.”

The conundrum of stagflation

The simultaneous rise in inflation and unemployment baffled economists and politicians in the 1970s.

Any Economics 101 course would tell you that the macroeconomic problems of inflation and unemployment have an inverse relationship. That high inflation occurs during periods of low unemployment, and vice versa.

Stagflation inverts this theory by associating high inflation with higher unemployment and slower growth.

Its resolution is an enigma. Levers used to fight inflation could slow the economy and increase unemployment, while efforts to stimulate economic growth could drive prices higher.

“It creates a bit of a quagmire for politicians,” says Mr. Bergman. When the inverse relationship between unemployment and inflation is reversed, a political dichotomy is generated. »

The challenge facing the Bank of Canada is to raise interest rates enough to control inflation without triggering a recession.

In an unprecedented move, the central bank on Wednesday raised its benchmark rate for the second time in two months, taking it to 1.5%.

But no one knows if this will be enough to moderate inflation.

Absence of “stuck aspects”

Annual inflation hit 6.8% in April, marking the fastest year-on-year rise in consumer prices in more than three decades.

Finding the ideal level for interest rates is complicated by the fact that there is a lag effect between higher rates and the influence on consumer spending and business investment.

“They walk on a wire and it’s like a balancing act,” Mr. Bergman illustrates. We’re going to see the economy slow down and […] we could find ourselves close to the brink of a recession. »

In a speech last month, Bank of Canada Deputy Governor Toni Gravelle said comparisons between the current acceleration in inflation and the period of stagflation in the 1970s were not warranted.

“You don’t see the stagnant aspects of stagflation, quite the opposite,” he said. Many measures indicate that the Canadian economy is running at full speed. »

While higher interest rates will reduce demand and slow growth, they should also reduce inflation, reducing the inflationary component of stagflation, he explained.

The problem is that this may not be the case, economists argue.

Some factors are likely to persist pushing prices higher in Canada despite interest rate hikes.

“There are other forces that could keep inflation high, even if the economy slows down,” warns Nicolas Vincent, professor of economics at HEC Montreal.

“We continue to be affected by supply shocks. »

Russia’s invasion of Ukraine, China’s COVID-19 lockdowns and supply chain delays are fueling price increases.

These situations are likely to persist.

“The invasion of Ukraine and the experience of China ensure that we will have to wait at least another year before price pressures start to dissipate,” said Yalnizyan.

“The simplest tools we have in our toolbox are central bank policies, which by themselves will slow growth, but can make things worse, not better. […] it is a tightrope exercise. »

The stagflation problem that began in the 1970s did not end until the early 1980s, when the Bank of Canada raised interest rates to the point where the prime rate soared above 20%, noted the Conference Board of Canada in a recent analysis.

“Inflation and inflation expectations eventually plummeted, but that came at the cost of a brutal recession that pushed the unemployment rate to 12% in the early 1980s,” the Conference Board said in its report. March.

In other words, the remedy used to correct inflation could cause almost as many problems in other areas.

Record low unemployment rate

However, several current conditions are different from those of the 1970s and could help Canada avoid stagflation.

Canada’s unemployment rate fell to a record low of 5.2% in April, Statistics Canada reported last month.

The strength of the labor market and persistent labor shortages in various industries across the country stand in stark contrast to the high unemployment rate seen when baby boomers were young four decades ago.

“The job market is really hot,” says William Robson, president and CEO of the CD Howe Institute, a Toronto-based research group.

“There are parallels to the 1970s, but our unemployment rate is much better. »

Demographics and an aging population will also help keep unemployment at bay, he believes.

Canada could benefit from continued increases in commodity prices, which could even lead to a larger trade surplus.

In addition, the country is less unionized and fewer cost-of-living subsidies are incorporated into collective agreements and contracts.

“In the past, workers tried to catch up with price increases, otherwise they would lose purchasing power,” says Yalnizyan. This had led to a spiral of prices and wages in which one continued to feed the other. »

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