The Bank of Canada raised its key rate again, this time by 1 percentage point, the largest increase in 23 years. The governor warns that the key rate will continue to rise, to bring inflation back to around 2%.
The policy rate was eventually to rise. It could not remain around zero indefinitely. It had to increase so that it could be reduced again during a future recession.
The fight against inflation is a good reason to initiate these rate hikes. In fact, the number of vacancies is skyrocketing, unemployment rates are very low in most Canadian regions — it is 4.3% in Quebec. And, for now, economic growth is there.
But will these increases in the key rate succeed in stemming inflation? Allow me to doubt it. The current inflation is a worldwide phenomenon caused mainly by supply problems. It is a supply problem and not a demand problem. The reduction in domestic demand may ease inflationary pressures slightly, as people will buy less. But this strategy generates other risks. And the most serious of these risks is that of harming the adjustment of supply chains, the root cause of inflation, as well as the urgent economic transition to counter the effects of climate change by causing a recession.
High interest rates act as a deterrent to the private investment that is needed to re-establish supply chains in our economic world where globalization has increased uncertainty. They also hinder the adoption of green technologies.
The risks of recession and stagnation caused by a strategy of successive increases in interest rates can nevertheless be mitigated. This is my point.
If monetary policy aims to restrict demand, fiscal policy must counter supply problems.
To reduce the perverse effects and inevitable consequences of significant increases in the cost of credit, tax policy must be called upon. It must resolutely aim to increase investment and mainly the public investment necessary for a fair transition of the economy towards a zero greenhouse gas emission target.
However, in the context of higher interest rates, financial pressures will increase on governments to reduce their deficits accumulated during the pandemic and to make cuts in public spending as well as in social investment.
This is what happened during the period that continued through the 1980s and 1990s, when interest rates were high and governments wanted to reduce debt charges. Canada has experienced economic stagnation and public underinvestment, the effects of which are still being felt. We see it by looking at the state of our roads, our hospitals, our schools, and so on!
However, unlike in the 1980s and 1990s, the unemployment rate will rise less this time around as many baby boomers retire as the population ages. Positions may even remain vacant in certain sectors, such as construction, health and education, to name a few. Paradoxically, production could also decline. Ultimately, we could see near-full employment in Quebec and a contraction in production. Inflation could continue since supply problems could persist. In such a scenario, admittedly pessimistic, government deficits would increase. The dread of a balanced budget would resurface with renewed vigor.
Madam Minister of Finance of Canada—and I am speaking to her provincial counterparts as well—don’t forget the 1980s and 1990s. Don’t give in to popular pressure to balance budgets in a hurry. Instead, develop investment plans and adopt strict budgets. All too often, budgets are political responses to the shopping lists of all groups. It is time to have precise budgetary objectives associated with a fiscal anchor, and aimed at prosperity through the social investments necessary for a just transition.
To facilitate such a disciplined budgetary exercise, public accounting must be adapted to today’s realities. We must redefine the notion of capital to include intangible investment in human capital. This echoes the words of Mark Carney, former governor of the Bank of Canada, when, in his recent book, he proposed that the financial balance sheets of governments be used to balance short-term growth and long-term sustainable growth. He adds that it is important for governments to invest in public goods, such as training, and to have long-term visions.
David Dodge, also a former governor of the Bank of Canada, said in a recent appearance before the Standing Senate Committee on Banking and Commerce that governments should also invest more in training.
In short, in the coming months and years, we must not allow ourselves to be distracted by the speeches advocating the need to return to balance. You have to remember. We owe it to future generations.