This text is taken from the Courrier de l’économie of November 14, 2022. To subscribe, click here.
Interest rates are rising and will continue to rise until they trigger a recession and the recession solves the inflation problem! What kind of increase does it take to produce a recession? asks one reader, Wilfred Alliston. Perhaps the recession is already on its way. The United States is already there, Canada cannot be far behind…
There is no level of interest at which a recession is triggered. But we can fall back on the so-called neutral rate, defined as being the rate compatible with production that remains durably at its potential level and an inflation rate remaining at the target. This rate is currently in the 2-3% range. It is normally in the middle of the range, but the 3% bar is currently used as a benchmark. Any increase in the Bank of Canada’s key rate above this level takes monetary austerity into a restrictive zone, where it has a contractionary effect felt in particular on household demand and business investment.
In their fight against inflation remaining above their target (by 2%, middle of the 1-3% range), central banks are not aiming to trigger a recession, but rather trying to practice what the this is called a soft landing in economic activity. However, history teaches us that over the past fifty years, there have only been two periods of monetary tightening by the Bank of Canada that have not led to a recession, says the Oxford analyst firm Economics.
For his part, Hyun Song Shin, economic adviser and head of research at the Bank for International Settlements, identified 70 episodes of monetary austerity during the period 1980-2018 among 19 advanced economies and 6 emerging economies. Typically, proactive central bank action and a quick but short or moderate uptrend cycle lead to a soft landing. This is the strategy adopted by the Bank of Canada. However, in the current monetary austerity, the central banks reacted late in initiating their tightening phase.
Basically, this fight against the disorderly rise in prices boils down to an inflation-unemployment trade-off. However, the Bank of Canada must deal with excess demand combined with a supply shock fueled by distortions in the supply chain. With also the remnants of the wealth effect on households generated by the pandemic, combined with a shortage of labor maintaining the tension on the labor market. Added to this is the economic impact of this unprovoked war being waged by Russia against Ukraine, particularly on energy prices and the price of basic materials.
And in the United States
As for the end of your question, yes, the United States has had two consecutive quarters of GDP decline this year. But then to return to growth in the third quarter with an increase of 2.6% in annual rate of its GDP, according to an initial estimate published on 27 October.
It should be noted that in the United States we do not rely on the classic definition of a recession, ie at least two consecutive quarters of a decline in GDP. Rather, it is up to the National Bureau of Economic Research (NBER) to declare it officially. “A recession is the period between a peak in economic activity and its lowest point,” writes the NBER on its website, which points out that “a recession involves a significant decline in economic activity, widespread across the economy and lasts longer than a few months”.
For Canada, the central bank’s most recent scenario predicts that GDP growth will return to around 1.5% in the third quarter before decelerating further and settling between 0 and 0.5% until the end of 2022 and the first half of 2023. “This suggests that for a few quarters growth could be just a little below zero or slightly positive,” she wrote in her Report on the monetary policy published on 26 October. She doesn’t use the word recession, but…
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