A self-inflicted recession and a needless sacrifice to a mystical god at two percent
The Canadian economy has rebounded from the COVID-19 pandemic much faster than virtually any economist (myself included) would have dared to predict.
By October 2021 – 18 months after the fastest and deepest contraction in Canadian economic history – total employment had already recovered to its pre-COVID baseline.
The unemployment rate is now the lowest (5.1%) since Statistics Canada began collecting this data. Real GDP also fully regained its COVID-related losses at the end of 2021.
And the economy has gone from strength to strength ever since.
By any measure, this is a historic achievement – and a resounding validation of the extraordinary measures taken to protect the lives and livelihoods of Canadians during the pandemic.
But the celebration of this remarkable rebound has been cut short, replaced by grim pessimism.
There are now growing signs that the post-COVID comeback will be bungled, such as a Game 7 slump by the Maple Leafs – traded for an unnecessary recession.
More disappointingly, the pain will largely be self-inflicted.
Accelerating inflation is blamed for the coming storm, but that’s not the real culprit.
In reality, it is not inflation, but the policy response to inflation, that is about to derail the recovery.
After some initial hesitation, central bankers around the world (including in Canada) rediscovered the true austere religion. They pledge to bring inflation back to target (in Canada, it’s 2%) and to restore their “credibility” with the financial community, come what may.
Bank of Canada Deputy Governor Paul Beaudry said it bluntly: “At the end of the day, we’ll get inflation down to 2%, and we’ll do what it takes to get there.
It signals a willingness to trigger an outright recession if necessary to control inflation – even if the real and immediate costs of the recession (from lost jobs to lost homes to lost lives) are far greater than the consequences. current inflation.
This attitude evokes the American major in Vietnam who was ready to “destroy the city to save it”.
Reducing inflation from its current rate (7.7% in May) to 2% represents a reduction of nearly six percentage points. Over the past 70 years, no disinflation of this magnitude has occurred without a major recession.
But because that magic 2% goal was elevated above all other priorities, it looks like we’re going to do it anyway.
This unique determination is shared by central bankers around the world. They are stuck in a 1970s mindset in which unions and workers were supposed to push inflation ever higher in a rising spiral.
But this story has nothing to do with the current situation. Statistics confirm that labor costs did not cause today’s inflation.
On the contrary, the slow growth of wages and unit labor costs has contributed to moderating prices; at the same time, rising corporate profits explain most of the price increases.
Concerted global monetary tightening is already shocking expectations and stirring markets.
Early signs of stress can be seen in falling asset prices, including stocks, real estate and riskier assets like cryptocurrencies and emerging market debt.
Consumer and investor confidence is eroding, which can inflict self-fulfilling damage to future growth.
If a recession does occur, its aftershocks (exacerbated by overleveraged financiers, the still-unfinished pandemic, and war in Ukraine) will be far-reaching and unpredictable.
In addition to preparing for unnecessarily difficult times ahead, it is also a time to reconsider our overreliance on that one mighty hammer – central bank interest rates – to manage the ups and downs. bottom of the overall labor market.
When unemployment was high, sustainable ultra-low interest rates lost their effectiveness, more often causing undesirable effects (like a housing bubble) rather than real growth and job creation.
With unemployment low, we now face a diabolical choice between continued inflation and deliberate recession.
We need other strategies to spur growth when it’s needed and slow it down when it’s not.
Other tools could be invoked now to control inflation, such as strategic price controls, targeted taxes on corporations and high earners, and low-cost or free public services.
But mainstream orthodoxy demands monetary austerity, and nothing else.
Elevating inflation control above all other economic and social priorities seems likely to snatch defeat from the jaws of our post-COVID economic victory.
Decades from now, historians will shake their heads, wondering why today’s leaders were willing to throw away a miraculous economic recovery in a needless sacrifice to a mystical god at two percent.