After inflation, recession? | The Press

A pandemic, a war, soaring inflation and interest rate hikes. All the ingredients that cause recessions are presently present. Canada, despite a booming economy, is not immune to a sharp slowdown in growth.

Posted at 5:00 a.m.

Helene Baril

Helene Baril
The Press

Recession risks are on the rise, most economists agree. Since the Bank of Canada made clear its intention to raise rates quickly to calm inflation, the odds of a recession are increasing, says Steve Ambler, associate professor at the School of Management University of Quebec in Montreal and holder of the David Dodge Chair in Monetary Policy.

“Current interest rates, which are still very low after two hikes this year, will have to rise a lot more to combat inflation, which exceeds the Bank of Canada’s target of 4.6%,” he said.

How high can rates rise before the economy starts to falter? The Bank of Canada has in mind what it calls a neutral rate, which allows the economy to grow without causing inflation. This ideal (and theoretical) rate is around 2.5%, according to the monetary authorities.

However, given that inflation is currently above 6%, it is virtually certain that interest rates will have to be maintained above this neutral rate for some time, Steve Ambler believes.


BLAIR GABLE PHOTO, REUTERS ARCHIVES

Tiff Macklem, Governor of the Bank of Canada

The economy begins to suffer when interest rates exceed this rate considered ideal. The Governor of the Bank of Canada believes that the Canadian economy is able to withstand higher interest rates. The central bank forecasts economic growth of 4.2% this year and 3.2% in 2023. Even if these forecasts turn out to be too optimistic, there is still a margin before entering negative territory, a again pleaded Tiff Macklem before federal elected officials last week.

A recession, if necessary

The recession, if there is one, is not for this year, believe several economists, including Jean-François Perreault, chief economist of Scotiabank. The Bank of Canada has lifted its foot from the accelerator, but has not yet stepped on the brakes, he believes. Rate hikes will slow the machine down, but it still has enough fuel to keep going for several more months, he said.

The situation is different in Europe, where the war in Ukraine and rising energy prices have caused an economic shock.

Much of the current concern over the likelihood of a recession stems from what is happening in Ukraine. It is likely that in Europe, several countries will find themselves in recession.

Jean-François Perreault, Chief Economist of Scotiabank

If that happens, Canada will not suffer too much because it is a producer of raw materials that will find buyers elsewhere, if the European economy freezes. If the American economy suffers, on the other hand, the northern neighbor will not escape it.

On this side of the Atlantic, the main risk is inflation, says Jean-François Perreault, and how central banks will go about fighting it.

Raising interest rates will not lower the prices of oil and other commodities, but it will have the effect of calming consumption and the real estate frenzy. The Scotia economist points out that the Bank of Canada has repeatedly stated that it is committed to bringing inflation back to its 2% target, which suggests that it wants to get there at all costs, even at the cost of a recession.

Interest rates that are too high for too long inevitably lead to a recession. At least that is what recent history teaches us.

“It’s an avoidable scenario, however, believes Jimmy Jean, chief economist at Desjardins, but several things have to go well. »

First, central banks in both Canada and the United States must raise their rates more vigorously to stop stimulating the economy. “The longer we wait, the more we put ourselves at risk of having to raise rates further, and for longer. Rate hikes can take 18 to 24 months to have an impact on the real economy, he said.

If inflation shows signs of slowing down or leveling off, the odds of a soft landing will increase, says Jimmy Jean.

Finally, there must be no other shocks that hit the global economies.

Scenarios

Will the current combination of pandemic, war and inflation lead straight to a recession? Everything depends on the results obtained by the Bank of Canada and the Federal Reserve of the United States in the fight that has just begun against inflation.

Three scenarios are possible, summarizes Miville Tremblay, fellow of the CD Howe Institute and CIRANO, who is also a former Bank of Canada.

“The ideal is a soft landing, where demand calms down somewhat and inflation approaches 2% in a year or two,” he says. The second is stagflation, where growth falters a lot, but inflation persists due to shortages and supply shocks. The third is that of a recession where the rise in rates breaks the reins of growth. »

It is very difficult, he said, to attach probabilities to these scenarios, because of the unusual combination of factors currently affecting the global economy. “We must wish each other good luck! “, he concludes.

The ABC’s of recession

A recession is a decline in economic activity, measured by gross domestic product (GDP), for at least two consecutive quarters. It is characterized by a significant increase in the unemployment rate and a marked drop in consumption and investment that can last a few months or several years.

bearing

The damage caused by a recession is measured in lost production, but also in the human tragedies generated by job losses, bankruptcies and a drop in the standard of living.

The causes

A downturn in the economy is rarely caused by a single factor or event. It is usually the result of several causes such as excessive indebtedness, speculative bubbles or a shock caused by a pandemic, and which end up fueling inflation.

The last recessions in Canada

The pandemic caused a sudden and short-lived recession, very different from other episodes of decline in the Canadian economy. Before the big plunge of 2020, the last “normal” recession was in 2008.

1980-1982

The weak Canadian dollar and rising inflation prompted the Bank of Canada to raise interest rates and keep them high, causing Canada’s longest recession since the 1930s.

Duration: 6 terms

Key rate: 21%

Unemployment rate: 12.8%

GDP drop: 4.9%

1990-1992

It was again the fight against inflation through interest rate hikes that led Canada into a recession in 1990. Unlike the others, this recession was not caused by a slowdown in the American economy and it was considered the first recession made in Canada.

Duration: 5 terms

Key rate: 14.5%

Unemployment rate: 12%

Decline in GDP: 3.4%

2008-2009

The financial crisis in the United States and the collapse of the American real estate sector have shaken the international financial system and pushed the Canadian economy into a recession.

Duration: 3 terms

Key rate: 4.5%

Unemployment rate: 9%

Decline in GDP: 3.6%


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