Inflation Accelerates in July Despite Higher Unemployment

The uptick in July inflation reconfirms the absence of a predictable relation between inflation and unemployment, and should cast more doubt on the Bank of Canada’s current strategy to cool off prices by deliberately raising unemployment.

Unemployment in Canada has increased significantly since the Bank of Canada began raising rates in spring 2022. In the last 12 months, total unemployment increased by 155,000 persons, and the unemployment rate has risen by 0.6 percentage points (to 5.5% in July).

According to conventional doctrine, inflation should be inversely related to unemployment. This is the traditional ‘Phillips Curve’ theory, which sees most inflationary pressure arising from an ‘overheated’ labour market. (A full review and critique of that theory is contained in the Centre for Future Work’s 2022 paper, A Cure Worse than the Disease, pp. 6-9.)

But while unemployment has been steadily creeping up, concurrent inflation has not significantly slowed.

The ‘headline’ inflation rate reported in most media coverage is the year-over-year change in prices: comparing this month’s prices to their level a year earlier. This year-over-year measure is often strongly affected by price changes that happened many months ago.

For example, the surge in global oil and energy prices that followed the invasion of Ukraine last spring caused a sudden surge in price levels – pushing year-over-year inflation to a peak of 8.1% in June 2022. A sudden surge like that will impact year-over-year rates for many months afterward, even if further growth in prices is moderate.

The decline in year-over-year inflation rates over the subsequent year (falling to 2.8% a year later, in June 2023) mostly reflected the gradual dissipation of that temporary price shock, rather than a decline in broader inflation.

To get a more accurate picture of the immediate pace of inflation, therefore, many economists prefer more immediate measures of price change. A common approach is to consider the change in prices over the most recent three months, annualized to a format comparable with annual rates. Measured by this concurrent 3-month annualized rate, inflation has not consistently slowed at all in the last year.

The chart below compares the unemployment rate to both measures of inflation: the usual year-over-year (headline) rate, and the more up-to-date three-month annualized change. Concurrent three-month inflation has hovered at or below 3% since last August, despite the gradual but significant increase in unemployment over that time.

Headline inflation ticked up in June, mostly due to the elimination of last June’s gasoline price spike from the year-over-year calculations (called a ‘base year effect’ by economists). However, three-month inflation didn’t change, staying steady at 3.1% (annualized). Indeed, the concurrent three-month inflation rate is presently higher than it was in late autumn 2022 and early 2023.

The engineered increase in unemployment (driven both by high interest rates to slow job-creation and labour demand, and by unprecedented increases in immigration aimed at quickly boosting labour supply) has thus had no visible impact on ongoing inflation.

The lack of correlation between unemployment and concurrent inflation is more starkly obvious in the following scatter plot, which compares unemployment (measured along the horizontal axis) with inflation (along the vertical axis). According to the Phillips Curve theory accepted by the Bank of Canada, this scatter plot should form a predictable downward relationship: higher unemployment should cause lower inflation, and vice versa.

In reality, however, there is no correlation in this relationship at all: it’s a jumble of seemingly random dots. (In fact, a linear regression trend line shows a very weak, non-significant positive relationship between the two variables, opposite to conventional Phillips Curve assumptions.)

Because post-pandemic inflation was clearly caused by factors outside of the labour market (namely, supply chain disruptions, shortages of key commodities, the energy price shock following the Ukraine invasion, and aggressive profit-taking by corporations in strategic sectors of the economy), it is not surprising that the engineered increase in unemployment over the past year has had no visible impact on price increases.

The future course of inflation will be equally hard to predict, on the basis of developments in the labour market alone. For example, world oil prices (set on highly financialized futures markets) have increased by about $10 (U.S.) per barrel in the last month, driven by speculation that output cuts by OPEC and Russia might reduce future supply. In Canada’s privatized energy market, those futures market developments flow straight into domestic prices for gasoline, fuel oil and natural gas – and further boost the record profits pocketed in the last two years by the petroleum industry. That would undo much of the progress in reducing inflation that has been recorded over the past year. And simply creating still more unemployment in the labour market won’t stop it.

In essence, the 155,000 additional Canadians pushed into unemployment in the past year, and hundreds of thousands more whose jobs are jeopardized by continuing monetary austerity, are macroeconomic hostages. They did not cause current inflation. But they are being punished in an effort to reduce inflation faster and further, in line with the Bank of Canada’s one-dimensional mission. Worst of all, their sacrifice is to no avail: so far, higher unemployment has had no visible impact on inflation at all.

There is no doubt that by punishing workers, stalling the economy, and elevating unemployment more dramatically, the Bank of Canada could eventually wring inflation out of the economy – regardless of the fact that inflation did not arise from excess employment or spending power among Canadian workers. By causing a slowdown big and painful enough to forcibly suppress spending, the impact of other inflationary pressures (even record corporate profit-taking) can be offset, and inflation correspondingly reduced.

But this strategy is as inefficient as it is unfair. We’d be better off to target the true causes of inflation: by regulating prices of essential commodities (like energy, rents, and key foodstuffs), capping and taxing back excess corporate profits, and stimulating more supply of housing (rather than suppressing construction with high interest rates, driving housing costs higher).

Inflation has abated significantly since the price surge a year ago. That progress had little to do with higher interest rates. And the next yards of the inflation battle are going to be much harder to traverse. Misplaced finger-pointing at workers’ wages is going to get louder. And workers and unions will need to fight harder than ever for an anti-inflation strategy that addresses the true causes of inflation, rather than scapegoating its victims.