Canada is leaning towards a new era of 1970s-style stagflation as economic growth slows but inflation remains stubbornly high, economists say.
An abnormal mix of rising prices and high unemployment gripped the country an odd 40 years ago.
Supply shocks have caused energy prices to rise sharply, interest rates have skyrocketed and unemployment is rising.
Now some experts claim that the conditions for the return of the economic phenomenon are ripe.
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“I would say that next year we are looking at a recession in this country that, combined with continuing inflation, could mean stagflation,” said Armine Yalnizyan, an economist and member of the Atkinson Foundation.
“We can’t avoid the global forces that point to the recession … the question is whether raising interest rates will slow inflation.”
Although stagflation could return, it would probably be a milder version of the economic anomaly – a kind of stagflace-lite.
“I don’t think it’s unrealistic to expect a world where we can have higher inflation and higher unemployment,” said Fred Bergman, senior political analyst at Atlantic Provinces Economic Council, an independent economic think tank based in Halifax.
“We saw the two of them watching, which is rare.” But it will be very modest compared to what we saw in the 70’s and 80’s. “
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The current rise in inflation and unemployment has stopped economists and policy makers in the 1970s.
Economy 101 would say that the macroeconomic problems of inflation and unemployment have an inverse relationship. High inflation occurs during periods of low unemployment and vice versa.
Stagflation breaks this theory by combining high inflation with rising unemployment and slowing growth.
Its solution is a puzzle. The levers used to tackle inflation could slow the economy and increase unemployment, while efforts to accelerate economic growth could boost price growth.
“It creates a bit of a swamp for politicians,” Bergman said. “When the inverse relationship between unemployment and inflation is reversed, it leads to a political dichotomy.”
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The challenge facing the Bank of Canada is to raise interest rates enough to curb inflation but not trigger a recession.
On Wednesday, the central bank raised its key interest rate for the second time in two months in an unprecedented step, reducing its key interest rate to 1.5 percent.
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However, it is not clear whether this will be enough to reduce inflation.
The year-on-year inflation rate rose to 6.8 percent in April, the fastest year-on-year increase in more than three decades.
Finding a sweet interest rate point is complicated by the fact that there is a lag between higher rates and the impact on consumer spending and business investment.
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“They’re on a fine line and it’s a bit of a balance,” Bergman said. “We will see a slowdown in the economy and … we could move to the brink of recession.”
In a speech last month, Bank of Canada Deputy Governor Toni Gravelle said a comparison between rising inflation and the period of stagflation in the 1970s was not justified.
“We don’t see a stagnant part of stagflation – quite the opposite,” he said. “The Canadian economy is pretty hot across many standards.”
While higher interest rates will reduce demand and slow growth, they should also reduce inflation – undermining the inflationary component of stagflation, he said.
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The problem is that they don’t have to, economists say.
Some of the factors pushing up prices in Canada are likely to continue despite higher interest rates.
“There are other forces that can keep inflation high even as the economy declines,” said Nicolas Vincent, a professor of economics at HEC Montreal.
“We’re still hit by supply shocks.”
The Russian invasion of Ukraine, the COVID-19 lockout in China and the backward supply chain all contribute to higher prices.
These situations are likely to continue.
“The invasion of Ukraine and the experience of China ensure that we look forward to at least another year until price pressures begin to ease,” Yalnizyan said.
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“The simplest tools we have in our toolkit are central bank policies, which in themselves slow down growth but risk worsening the situation and not improving it – it’s a rope exercise.”
The stagflation problem, which began in the 1970s, did not end until the early 1980s, when the Bank of Canada raised interest rates to a point where the primary lending rate soared above 20 percent, according to a recent analysis by the Conference Board of Canada.
“Inflation and inflation expectations eventually collapsed, but it was worth the brutal recession, which saw the unemployment rate reach 12 percent in the early 1980s,” the Conference Board said in a March report.
In other words, the means used to correct inflation could cause almost the same pain in other areas.
Nevertheless, several conditions today are different than in the 1970s and could help Canada avoid stagflation.
Unemployment in Canada fell to a record low of 5.2 percent in April, the Canadian Bureau of Statistics said last month.
The strong labor market and the continuing labor shortages in several industries across the country are in stark contrast to the high unemployment rates seen when baby boomers were young four decades ago.
“The job market is really hot,” said William Robson, president and CEO of CD’s Howe Institute, a Toronto-based think tank.
“There are parallels with the 1970s, but our unemployment rate is in a much better place.”
Demography and an aging population will also help keep unemployment in check, he added.
Canada could benefit from continued higher commodity prices, which could potentially trigger a higher trade surplus.
The country, meanwhile, has a significantly smaller trade union with fewer living costs contributions baked in collective agreements and agreements.
“Employees have tried to catch up with prices in the past because otherwise they would lose purchasing power,” Yalnizyan said. “It led to a spiral of price and wages, where one still fed the other.”
This report from The Canadian Press was first published on June 1, 2022.
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