With economic growth stalling and inflation remaining stubbornly high, Canada appears to be heading for a new period of stagflation, the last episode of which dates back to the 1970s, economists observe.
Posted at 2:43 p.m.
The anomalous mix of price hikes and high unemployment captured the country’s collective imagination some 40 years ago. Supply shocks had skyrocketed energy costs, interest rates had reached devastating heights, and unemployment was rampant.
Today, some experts point out that the conditions are met 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,” notes Armine Yalnizyan, economist and member of the Atkinson Foundation.
“We cannot dodge the global forces that are pointing towards recession […], the question is whether rising interest rates will slow inflation. »
But this return to stagflation could present a milder version of this economic anomaly.
“I don’t think it’s unrealistic to expect to see a world where inflation and unemployment will rise,” said Fred Bergman, senior policy analyst at the Atlantic Provinces Economic Council, a think tank independent business based in Halifax.
“We could see these two (elements) climbing 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 policymakers in the 1970s.
Any Economics 101 course would say that the macroeconomic issues of inflation and unemployment have an inverse relationship. That high inflation occurs during periods of low unemployment, and vice versa.
Stagflation reverses this theory by associating high inflation with rising unemployment and slowing growth.
Its resolution is an enigma. Levers used to fight inflation could slow the economy and drive up unemployment, while efforts to stimulate economic growth could fuel higher prices.
“It creates a bit of a quagmire for politicians,” notes Mr. Bergman. When the inverse relationship between unemployment and inflation is reversed, it leads to a political dichotomy. »
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 key rate for the second time in two months, bringing its key rate to 1.5%.
But no one knows if this will be enough to temper inflation.
Absence of “stagnant aspects”
Annual inflation hit 6.8% in April, marking the fastest year-over-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 a bit of a balancing act, illustrates Mr. Bergman. We are going to see the economy slow down and […] we could find ourselves near the edge 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 unwarranted.
“You don’t see the stagnant aspects of stagflation — quite the contrary,” 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, say economists.
Some factors pushing prices higher in Canada are likely to persist 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 all 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 M.me Yalnizyan.
“The simplest tools we have in our toolbox are central bank policies, which themselves will slow growth, but they may make things worse, not better. […] it is a tightrope exercise. »
The problem of stagflation 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 %, pointed out the Conference Board of Canada in a recent analysis.
“Inflation and inflation expectations eventually plunged, but that came at the cost of a brutal recession that saw the unemployment rate hit 12% in the early 1980s,” the Conference Board said. in its March report.
In other words, the remedy used to correct inflation could cause almost as many problems in other areas.
Record low unemployment rate
Yet several conditions today 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 job market and the persistent labor shortage in several industries across the country contrasts sharply with the high unemployment rate recorded when baby boomers were young four decades ago.
“The job market is really active,” 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 the continued rise in commodity prices, which could even generate a higher trade surplus.
In addition, the country is less heavily unionised, and fewer cost-of-living allowances 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 Ms.me Yalnizyan. This had led to a price-wage spiral where one continued to fuel the other. »