The Bank of Canada has increased interest rates three times since March, with another (potentially large) increase predicted on July 13. Other central banks around the world are also quickly increasing interest rates to reduce domestic spending, slow down growth and job-creation, and try to reduce inflation back to their preferred targets (2% in Canada’s case). In this commentary (originally published in the Toronto Star), Centre for Future Work Director Jim Stanford considers the risks that this reflexive response to inflation will derail the strong economic recovery that has been experienced since the pandemic.
A Pointless Sacrifice to a Mystical Two Per Cent God
By Jim Stanford
Canada’s economy rebounded from the COVID-19 pandemic far faster than virtually any economist (myself included) would dare predict. By October 2021 – 18 months after the fastest, deepest contraction in Canada’s economic history – total employment had already regained its pre-COVID benchmark. Unemployment is now the lowest (5.1%) since Statistics Canada started collecting this data. Real GDP also fully regained its COVID losses by late 2021. And the economy has kept charging forward since then.
By any measure, this is a historic achievement – and a ringing validation of the extraordinary measures taken to protect the lives and livelihoods of Canadians during the pandemic.
But celebration of this remarkable rebound has been cut short, replaced by dark pessimism. There are now growing signs the post-COVID comeback will be squandered, like a Game 7 collapse by the Maple Leafs – traded for a needless recession. Most disappointing, the pain will be largely self-inflicted.
Accelerating inflation is blamed for the coming storm, but it isn’t the true culprit. In reality it’s not inflation, but the policy response to inflation, that is poised to derail the recovery. After some initial hesitation, central bankers around the world (including in Canada) have rediscovered austere true religion. They are pledging to drag inflation back to target (in Canada, that’s 2%), and reestablish their “credibility” with the financial community, no matter what.
The Bank of Canada’s Deputy Governor, Paul Beaudry, put it bluntly: “The bottom line is we will get inflation back to two per cent and we’ll do what’s necessary to get there.” That signals a willingness to spark outright recession if needed to control inflation – even though the real and immediate costs of recession (from lost jobs to lost homes to lost lives) are far more severe than the consequences of current inflation. This attitude evokes the US major in Vietnam who was willing “to destroy the town to save it.”
Reducing inflation from its current rate (7.7% in May) to 2% is a reduction of almost 6 percentage points. In the last 70 years, no disinflation of that magnitude occurred without a major recession. But because that magic 2% target has been elevated above all other priorities, it seems we’re going to do it anyway.
This single-minded determination is shared by central bankers around the world. They’re stuck in a 1970s mindset in which unions and workers supposedly drove inflation ever-higher in an escalating spiral. But that narrative has no relevance to the current situation. Statistics confirm labour costs did not cause today’s inflation. To the contrary, slow growth in wages and unit labour costs has helped moderate prices; meanwhile, higher business profits account for the bulk of price increases.
Concerted worldwide monetary tightening is already shocking expectations and roiling markets. Early signs of stress are visible in plunging asset prices: including equities, real estate, and riskier assets like cryptocurrencies and emerging market debt. Consumer and investor confidence is crumbling, and that can inflict self-fulfilling damage on future growth. If a recession occurs, its aftershocks (exacerbated by over-leveraged financiers, the still-unfinished pandemic, and war in Ukraine) will be wide-ranging and unpredictable.
Apart from preparing for needlessly tough times ahead, this is also a time to reconsider our overreliance on this one powerful sledgehammer – central bank interest rates – to manage the ups and downs of the entire labour market. When unemployment was high, lasting ultra-low interest rates lost their effectiveness, more often causing undesired effects (like a housing bubble) rather than real growth and job-creation. With unemployment low, we now face a devil’s choice between continued inflation and deliberate recession. We need other strategies for motivating growth when needed, and slowing it when it’s not.
Other tools could be invoked right now to control inflation: like strategic price controls, targeted taxes on corporations and high-income earners, and low-cost or free public services. But the dominant orthodoxy demands monetary austerity, and nothing else.
The elevation of inflation control over all other economic and social priorities seems likely to snatch defeat from the jaws of our post-COVID economic victory. Decades from now historians will shake their heads, wondering why today’s leaders were willing to throw away a miraculous economic recovery – in a pointless sacrifice to a mystical 2% god.