After years of helping to lower the cost of living, international trade is increasingly likely to expose Canada to inflationary factors from outside. Its central bank will then have no choice but to respond as it has just done, warns its governor, namely by weighing down the economy and employment in the country with interest rate increases.
The last time a Bank of Canada governor addressed the Canada-United Kingdom Chamber of Commerce, Stephen Poloz told his audience about low global interest rates, the continued reduction in inflation risks and the successful conclusion of free trade negotiations in North America.
“How the world has changed in six years!” exclaimed his successor, Tiff Macklem, on Tuesday at the same forum in London.
Today, interest rates at most of the world’s major central banks are only just beginning to come down from their multi-decade highs, where they were set to quell soaring inflation. And international trade has changed since the COVID-19 pandemic, deepening rivalry between China and the West, rising protectionism, Russia’s invasion of Ukraine, and climate disasters.
New business context
In this regard, “one thing seems clear: international trade will be different in the years to come,” summarized the Governor of the Bank of Canada during a speech on the nature and effects of these transformations.
Trade liberalization and globalization have long been synonymous with economic growth, catching up by poorer countries, economies of scale and productivity gains that translate, “for consumers, into more choice and better prices.”
But the loss of political and public support, rising geopolitical tensions and the search for economic security have “restructured, reshaped and redirected” trade, Macklem noted. Once faster than global economic growth, global trade growth is now slower, particularly in developed economies. The remaining growth is concentrated in services rather than goods. Trade is also fragmenting, with many countries seeking to reduce their exposure to China.
Instead of contributing, as before, to “significantly lowering the prices of many traded goods”, this new version of international trade “could accentuate upward pressure on inflation”, said the central banker.
“A difficult arbitration”
But that’s not all. As the latest spike in the cost of living has shown, all these “trade disruptions can also cause greater variability in inflation” and create “supply shocks.” That is, inflation that comes not from too much consumer and business demand, but from businesses struggling to meet that demand.
Supply shocks are usually transitory, which is why it is important, Macklem explained, to develop all sorts of measurement and analysis tools to differentiate and characterize the two types of shocks. But supply shocks can persist and accumulate, to the point of having “an outsized effect on inflation.”
This presents “central banks with a difficult trade-off.” Since their main tool of intervention is setting interest rates, they have no recourse but to raise them to curb demand from their own consumers and businesses and, by extension, economic growth and employment, even if the main source of the problem lies elsewhere. If only to show that they take the problem seriously and that they intend to control inflation, whatever the cost.
This is because “we must avoid adding uncertainty to an already uncertain environment,” Macklem concluded. “This means ensuring that inflation is kept low, stable and predictable, even at a time when international trade is being restructured, reworked and reoriented.”