THE STANDING SENATE COMMITTEE ON BANKING, COMMERCE AND THE ECONOMY
EVIDENCE
OTTAWA, Thursday, September 29, 2022
The Standing Senate Committee on Banking, Commerce and the Economy met with videoconference this day at 11:30 a.m. [ET] to study matters relating to banking, trade and commerce generally, as described in rule 12-7(8).
Senator Pamela Wallin (Chair) in the chair.
[English]
The Chair: Welcome to this meeting of the Standing Senate Committee on Banking, Commerce and the Economy. My name is Pamela Wallin, and I am the chair of this committee. I’ll introduce other committee members now. We have Senator Deacon, Senator Bellemare, Senator Gignac, Senator Loffreda, Senator Massicotte, Senator Ringuette, Senator Smith, Senator Marwah, who is here today for Senator Woo, and Senator Yussuff.
As we begin and continue this discussion on the state of the Canadian economy and inflation, I’m going to ask senators to make sure they keep preambles to their questions as concise as possible and the questions to the point because we have a lot of ground to cover.
For our first panel today, we have the pleasure of welcoming Trevor Tombe, Professor of Economics at the University of Calgary. He has just released a report, literally, September 2022, called The Rise (And Fall?) of Inflation in Canada: A Detailed Analysis of Its Post-Pandemic Experience.
Professor Tombe, we will ask you to begin with a few opening remarks. Thank you.
Trevor Tombe, Professor of Economics, University of Calgary, as an individual: Thank you, Senator Wallin. And thank you to the committee for the opportunity to appear before you today.
As noted, I’ll focus my opening remarks on recently rising inflation, but I’m happy to take more general questions relating to Canada’s economy later on.
I’ll begin with where we are today. Canada’s inflation rate reached a peak in June of 8.1%, up sharply from 3.1% one year earlier. That’s the highest rate of inflation since the early 1980s as is well known, but more importantly, it is the fastest acceleration in the rate of inflation since the early 1950s. It’s been some time since we’ve gone through an inflationary experience like this.
That has eased somewhat recently falling to 7% in August, but this remains substantially above Canada’s goal of 1% to 3% annually. So Canadians and their policy-makers are right to be concerned.
Much of the public commentary and debate on this topic lacks a clear and nuanced understanding of the underlying drivers relating to these high rates. That’s what I and my University of Calgary colleague Professor Yu Chen tried to do in the paper that I believe the committee now has with it.
I should say off the top that this is a working paper and not yet peer reviewed, so consider these results preliminary and subject to revision, although I do have great confidence in them, so I’m happy to talk about them with you today.
Without going into detail, it’s possible to decompose what the changes in the overall headline rate of inflation is into specific goods and services items that are included in that. One item in particular, energy, stands out as the largest contributor by far. Consider that peak rate of inflation of 8.1% in June. Back in 2019, that same month of June had a 2% rate of inflation. Rising energy prices account for almost half of that change, nearly 3 full percentage points. Add to that rising shelter costs and in particular a measure of a non-cash item capturing homeowners’ depreciation, which mechanically rises and falls with new home prices. We find that those two factors alone account for two thirds of inflation’s rapid rise.
To be clear, this doesn’t mean that other goods and services are not experiencing price increases. Nearly 80% of items in the Consumer Price Index, or CPI, now have annual price increases of over 3%, and 60% have increases of over 5%. But rising energy prices may account for some of that as well.
In the paper, we detail that potentially as much as 60% of the non-energy inflation in recent months is due to items that historically are sensitive to oil prices. That is, they move up and down with energy costs; things such as groceries, flights, restaurant meals and more.
In addition, we also in the paper characterize the underlying driving factors leading to price increases and separate demand versus supply-driven factors. You can think of demand-driven price increases as being associated with increases in both price and quantities consumed by individuals and supply-driven price increases have quantities falling as prices rise. We find that over the past year, or for the year ending in the second quarter of this year, that three quarters of the rise in inflation is supply-driven and about 15% is demand-driven.
Those results suggest that policies that boost demand, such as loose fiscal or monetary policy, may not be the critical factor leading to rapidly rising inflation rates today.
I have a couple of minutes, so I’ll conclude on one critical but under-appreciated point, and that is inflation rates are year‑over‑year comparisons. So it takes time for new developments to show up. Past short-term episodes of price increases will also persist in the headline rate even after the underlying price pressures have dissipated.
In August, for example, I estimate that 5.5 percentage points of the overall 7% inflation rate is due to price increases that occurred between January and May of this year. In recent months, price increases have not exceeded our goal of low and stable inflation.
Over the past three months, for example, the annualized inflation rate was 2.9% using the seasonal adjusted data and 1.9% using the raw data. If monthly inflation continues to be consistent with our 1% to 3% goal, it would still take until May of next year for the headline rate to fall below 3%. And that headline rate remains at 6% until January. While it’s too soon to know for sure, it may be that the period of unusually high inflation rates is already behind us. The data doesn’t necessarily imply that, but it is consistent with that possibility.
I’ll wrap up here and note that this relatively optimistic outlook does come with some risk if individuals and businesses increasingly expect persistent inflation. This can affect wage and price-setting behaviours that ultimately create the very inflation that was expected in the first place. Clear communication from policy-makers, central bankers and political leaders of all stripes may help ensure that long-run expectations do not stray too far from our 2% goal.
Thank you again for the opportunity to appear and I look forward to the conversation with you today.
The Chair: Thank you, Professor Tombe. I want to start with a general point because you’ve just made the point that energy is the largest contributor by far to the inflation numbers. We also had a Bank of Canada report, authored by the budget office inside there, that carbon taxes they think may slow economic growth for decades.
If you put those two things together, that creates some concern.
Mr. Tombe: There are certainly economic costs associated with any action on climate, carbon taxes included. Estimates do vary, but consensus would be, I think, consistent with the report you’re referencing that the ratcheting up of carbon taxes through 2030 may shave about 0.1% per year off growth give or take, and that accumulates through time, so it is a meaningful economic cost. That is a separate issue from inflation more generally as this is something that gradually ratchets up overall fuel price levels. It does have an effect on inflation, but that is modest.
The Chair: Thank you for setting the stage.
Senator C. Deacon: Thank you, Mr. Tombe, for the time and your clear comments.
I want to zero in on those elements that we have a little bit more control over other than the global price of oil.
One of them was raised by the former Bank of Canada governor, David Dodge. He talked with us about the constrained supply we’re experiencing in a number of sectors due to our aging population and shrinking workforce, pressures around decarbonization and deglobalization or “friend-shoring” — I think is what we’re calling it now — in terms of all the other elements that you have identified, really are quite a small percentage of the overall hit in terms of inflation.
What are your thoughts on those sorts of factors? He indicated that we need to see a lot more investment in technologies that will allow us to become more productive to improve our labour productivity to offset those factors that are constraining supply in a lot of different sectors. Do you have comments on that?
Mr. Tombe: I do. I’ll reference some of the research results in the paper that my colleague and I find.
When I mentioned supply shocks as a driver of recent inflation increases in Canada, energy and fuel is a big part of that, but we also find that important contributors to supply-driven inflation included things like new vehicles, vehicle parts and household appliances — things that are, in many areas, imported from elsewhere or subject to global supply-chain disruptions, in China, in particular, when we’re talking about household appliances. Those were key drivers on the supply side as well.
It is appropriate for us to think about more resilient supply chains. I know that global corporations are prioritizing those efforts and governments can do so. But these are longer-term measures that, if they do have implications for Canada’s productivity, matter a lot for our standard of living overall, but there really aren’t tools available to address the short-term challenges of rising inflation rates.
Canada’s productivity challenges are longstanding issues for this country, especially relative to the United States, and that gap between our productivity growth in recent decades and theirs is important. Addressing that involves a lot of different options.
I would caution, though, against friend-shoring, as you put it, or deglobalization as a way to boost productivity. At the margins, that tends to detract from productivity. It may be worth incurring that economic cost in order to achieve more stability, especially in critical areas relating to, say, health care supplies and technology or vaccine production.
Senator C. Deacon: To be clear — and I clearly wasn’t — he was identifying that as one of the pressures on our supply side versus part of the solution.
Thank you very much. Productivity growth is a major challenge and is related mainly to our very low levels of business investment in many ways, you could argue. Do you have any comments on ways to improve business investment in this country, which has been lagging for generations?
Mr. Tombe: Business investment lags in recent years are also driven by oil and gas — large drops in investment in that sector, and in Alberta in particular. That’s driven from low oil prices, globally, relative to pre-2015 and 2016 levels. That’s an optimal response, though, to lower global oil prices.
When I think about productivity, I think less about ways to boost investment versus ways of improving economic efficiency in Canada. Things that are available to policy-makers here that I know this committee has studied in the past include improving interprovincial trade, for example. I cite that as an area where I have also done a great deal of research. It potentially contributes measurably and significantly to low productivity in Canada overall.
Improving the ability to produce and sell across provincial borders can increase productivity, and it might have an effect on business investment levels.
Senator C. Deacon: Thank you.
Senator Smith: The recent fiscal sustainability report by the Parliamentary Budget Officer, or PBO, talked about the aging population and the movement toward greater numbers shifting into retirement. You note in some of your work that it’s more concerning than the “great resignation” that occurred during the pandemic.
One way of counteracting that could be by increasing immigration. I’m wondering if you could comment on that in terms of whether it is a realistic objective facing what we do face in terms of the inability in certain countries to get people into our country. Please comment on the challenges around immigration and whether it’s a realistic opportunity for us or if we should be looking at something more like trying to make sure we deregulate and make things simpler for people to do things in our country.
Mr. Tombe: Thank you for the question, senator. That’s a really important point.
Demographics are, by far, the biggest challenge that governments in Canada face over the coming two decades. It has implications for economic growth, based on the latest Statistics Canada demographic projections. Falling labour force participation as individuals enter their retirement years will maybe shave off 0.3% off economic growth annually between now and the early 2040s. That’s significant as it accumulates over that time.
Add to that the pressures on provincial health care systems, which, fiscally speaking, are enormous. No provincial government is yet ready to handle that mounting fiscal pressure.
These projections that Statistics Canada and others produce that form the foundation of the Debt Sustainability Reports from the PBO or my own work includes historically normal patterns of migration, both across provinces and internationally. So our aging population is something that is not addressed fully through immigration, because we have that aging population pattern in these projections even with historically normal levels of immigration.
Whether we should boost those levels comes with important trade-offs that I wouldn’t have the expertise to weigh in on. I’ll just note that the aging population is something that demographic projections find even with international migration.
Senator Smith: Is there an opportunity for us to encourage people who have retired to come back, like health care professionals and professionals, period? There seems to be an opportunity, but is it a real opportunity that could be quantifiable and something that could benefit our country?
Mr. Tombe: Increasing labour force participation rates among older-aged individuals is something we’ve been seeing in the data already in recent years. Technological advancements or changes in the nature of work may facilitate further increases in the years to come, and that would be an important way in which an aging population wouldn’t detract as much from economic growth as some of our baseline projections suggest.
Senator Smith: Thank you.
Senator Loffreda: Thank you for being here, Professor Tombe.
I’d like to dig a little deeper into business investment, which is so important. Senator Deacon brought it up. Kudos on your research.
I was looking at another piece of research. The Modus Research poll of 600 businesses found that nearly half of the companies intend to reduce investment in new equipment, 35% plan to cut R&D and 70% said it will prompt them to cut costs.
How would you compare this inflationary period with others that we have experienced in the past? Are you concerned that capacity and productivity growth, which are much needed in Canada, will be greatly affected in the long term and will accentuate the economy’s ability to grow?
Through your research, are there any further policies you can share with us that would help alleviate this risk? As we all know, it’s not just a question of supply and demand, but are there any policies that can stimulate our businesses to keep investing?
Mr. Tombe: That is an important question. I would, again, separate business investment and productivity issues from inflation. One is a very important longer-term consideration that policy-makers absolutely should be focused on, whereas the inflation pressures we are seeing are really driven by external, short-term — in my view — supply-related factors, energy prices in particular.
Investment is potentially related to the high rates of inflation through the real estate market, for example. I mentioned that the second-largest contributor to rising inflation rates in Canada is shelter costs and homeowners’ replacement costs, in particular. It may very well be that we wouldn’t have seen the rapid increase in home prices had we had more responsive policies at the local and provincial levels that would have facilitated an increased supply of housing. That’s one type of investment that may have a really direct implication for the inflation patterns that we’re seeing now.
In terms of how to boost productivity levels into the future, in terms of achieving longer-term increases in productivity, I look to things that governments are doing that detract from economic efficiency, things that add cost to businesses. As I noted earlier, potentially operating across provincial boundaries is one critical area where I think Canada falls short in terms of making more progress on issues related to liberalizing internal trade. That’s something that would have an effect on productivity.
Boosting R&D, that’s an area where I don’t have expertise to weigh in on in terms of what policies may facilitate that, but there are lots of ways in which government policies can improve productivity. We shouldn’t view that as something related to the short-term pressures of inflation.
Senator Gignac: Welcome, Mr. Tombe. Yesterday, at the previous meeting, we had a question regarding the Canadian dollar and the impact on inflation. The Canadian dollar has shifted from 1.25 to 1.37, or if you prefer, from 80 cents to 72 cents.
I’m curious about the impact of the lower Canadian dollar on the CPI. Do you have a rule of thumb? I appreciate your optimism that in the last few months, the CPI looks to have decelerated, but at the same time, we see the Canadian dollar depreciating, and maybe the impact will be felt in the coming months. Do you have any rule of thumb for what impact the 5% depreciation of the Canadian dollar would have on inflation?
Mr. Tombe: I don’t have a rule of thumb in that way, but you’re right to note that the exchange rate can affect inflation because that affects the price for Canadian buyers of goods that are imported from abroad.
Today, the most important channel through which the exchange rate will be affecting inflation is through its effect on Canadian-dollar-denominated energy prices. Gasoline prices are higher than they would be in Canada had our exchange rate moved with oil prices in the way that it does historically, potentially 20% lower. That would have a direct effect on inflation.
In terms of how global oil prices affect inflation, a good rule of thumb there is that a $10 change per barrel is associated with a 0.3 or 0.4 percentage point change in the overall headline rate of inflation. That change in the price of oil can be driven from global developments or from Canada’s exchange rate changing.
Senator Gignac: If I may, it also affects a lot of things we import from Florida, such as oranges. It affects the food component and other components as well, such as transportation from the U.S. We import a lot of things from the U.S. I’m just trying to figure out your optimism with respect to the significant deceleration of inflation in the coming months.
Mr. Tombe: My optimism comes from the two big drivers of accelerating inflation rates in Canada: energy prices and shelter costs. Those have already begun to dissipate from their highs in June. Oil prices are now significantly below where they were at their peak in June, now about one third below. We’re seeing real estate prices also falling in many markets in Canada.
The biggest drivers of inflation have already started to ease, and in the past three months, we’re seeing relatively normal rates of overall price increases month over month. It’s just going to take time for that to manifest itself fully in that headline rate of inflation because we have to wait for the price increases that occurred in January through May to drop off of that particular statistic.
[Translation]
Senator Bellemare: Mr. Tombe, my question has to do with the coordination of monetary and fiscal policy. You said that three-quarters of the inflation was supply-driven, and others have said the same. As you pointed out, the monetary policy action of raising interest rates affects demand. Of course, reducing demand reduces price pressures, even when supply is driving inflation. However, this does not address the fundamental issue — the cause of inflation — which may be temporary.
In light of that, don’t you think using monetary policy, which will have a short-term effect on demand, could also have a negative impact on supply in the long term, when it comes to investments, for instance? Don’t you think it would be better to use fiscal policy, in other words, tax measures such as compensating Canadians for that temporary period of time? Unlike monetary policy, that wouldn’t have any long-term effects. With that approach, however, the provinces have more power over fiscal policy, and the federal government has more power over monetary policy. It’s like inviting all the governments in the country to work together to fight inflation.
Don’t you think we would be better off if governments acted in a more coordinated way?
[English]
Mr. Tombe: Thank you for the question, senator. You’re right to note that there are many policy tools available to governments to affect overall economic activity, such as inflation, prices and growth and so on and so forth.
My view is that the Bank of Canada has a clear mandate to achieve inflation of between 1% to 3%, and it has at its disposal only this one broad tool of either easing or tightening monetary policy through changing interest rates. It is entirely appropriate for the bank to respond in the way that it has, even though the underlying drivers of inflation are supply-driven. Rising rates will not themselves solve the supply-side challenges leading to high inflation rates. They will bring down aggregate demand, but that has the effect of lowering prices.
Now, it is a more costly approach to lowering inflation than if inflation was demand-driven, but it is the only tool at the Bank of Canada’s disposal, and historically, they have been incredibly successful at achieving their mandated inflation of between 1% to 3%.
It’s not necessarily the case also that rising rates will detract from business investment because there are other factors that also weigh against such investment; in particular, high levels of economic uncertainty, which are certainly high today and high through the pandemic for many reasons. To the extent that the monetary policy actions that we are seeing help us accelerate the return to more normal economic conditions and predictable rates of inflation, then that could boost business investment, even though, all else equal, higher interest rates at the margin would lower investment levels. To the extent that it helps us achieve a more predictable and stable, sustainable path of economic growth, that could be a net positive.
The Chair: Thank you for that.
Senator Massicotte: Thank you for being with us this morning. We very much appreciate it. I have two questions. They’re technical, but I’m in need of better understanding of the issue.
When David Dodge was with us two weeks ago, we raised the issue of immigration as being a solution to a lack of manpower. To us, it’s obvious, but he cautioned us. He was hesitant. What I read from his response was that this is all very good. You guys talk about immigration as being a solution, but there are costs to it, and some members of that immigration group may not be productive for maybe 10 to 20 years. It could be the kids, could be the family. There are all kinds of reasons our country accepts certain immigrants. But sometimes it’s not productivity-oriented but more convenience of the family and so on. I wouldn’t mind you explaining what else are we forgetting? Why the hesitancy, because to me it was so obvious?
The second question: I had a meeting a week ago with the President of McDonald’s Canada. For some reason, which I don’t understand, she said we have a serious shortage of manpower but only principally in Quebec, whereby they introduced the McChicken for those who are fans of McDonald’s, and they had to actually cut the menu on other items to allow them to have the product base adequate for the new McChicken product. Why is it only in Quebec? I know Quebec has an average older population. But why Quebec more than others? If you could explain more the complexity of immigration, why it is not always easy and productive, I’d appreciate it.
Mr. Tombe: Thank you for the question, senator. Unfortunately, for both of those questions I will have to decline to offer my thoughts. I lack sufficient expertise in immigration policy to unpack what the factors are that would lead new immigrants to have initially lower levels of productivity. Presumably, there are many programmatic responses that governments can think about how to better integrate new immigrants into the labour market. There are certainly factors potentially related to recognizing foreign credentials that allow new immigrants to serve in sectors and occupations where they are best qualified to do so. But being outside my area of expertise, I wouldn’t be able to provide a lot of insight there.
With regard to potential challenges for employers in terms of recruitment and why that’s higher in Quebec, that is also something where I don’t have a lot of insight to share. Also, I didn’t realize that this was a Quebec-specific issue, so that’s interesting to hear. But afraid I won’t be much help.
Senator Massicotte: Thank you.
The Chair: Thank you. We also appreciate it when people say that, which is, “It’s not my area so I won’t weigh in.” That’s very good of you.
Senator Marwah: Thank you, Professor Tombe, for your comments. They were very enlightening. I would like to move to dealing with inflation and perhaps build on Senator Bellemare’s question. Given your research has shown that the causes of inflation are two thirds between energy and housing, now that we know that, can you comment on either the fiscal or monetary policy measures the government can take to deal with inflation in a very targeted way rather than the broad-based measure of rising interest rates?
Mr. Tombe: The Bank of Canada is constrained in the tools it has at its disposal. So it will pursue tighter monetary policy to bring down aggregate demand, to bring down the rate of inflation to their target. The federal government through its spending and taxation powers has a lot more tools at its disposal. Given that energy price increases are a particularly important source of rising inflation rates, one response of governments that we are seeing is to provide support to individuals who are particularly strained by those rising prices, lower-income individuals in particular.
So when the federal government boosts the GST credit, as it has announced it will do recently, that is, I think, an appropriate response. We are also seeing provincial governments provide cash transfers through different routes, either refundable tax credits or in Alberta rebates on people’s electricity bills or cash transfers. I think in British Columbia through ICBC.
Cash transfers to support individuals are, I think, an appropriate way to help individuals manage the pressures from rising inflation due largely to external factors beyond domestic policy-makers’ control.
With respect to shelter costs and rising housing prices, I think that’s something where the federal government can play some role, but the responsibility for ensuring housing supply increases appropriately with demand is really a local and provincial issue that I think we are starting to see governments take a little more seriously although there is still a lot more work on that front to go.
I’ll note that rising interest rates does have a large and direct effect on residential investment that is potentially something that is concerning given we do want to increase the amount of investment in that area.
Senator Ringuette: My question is in regard to how we compare to other countries. Recent OECD data, from August 2022, shows Japan’s inflation is at 3%; Switzerland roughly 3.7; Israel 4.7 and so on. We are at 7%. Why is it that Japan’s inflation is less than ours to that extent? And Switzerland and Israel. These are countries that are on a different geographic and geopolitical scale. I’m trying to understand what they are doing to have this low inflation in comparison to Canada.
Mr. Tombe: That is an important question, senator. Thank you. I will note that the average overall rate of inflation across all OECD economies in August was 10.3%. So Canada does have a below-average overall rate. Now, there are certainly countries, as you know, that have much lower rates, Japan in particular. But Japan has struggled for decades now in terms of its very low rate of inflation — and in some periods deflation — that its government has really aggressively tried to increase. Even today, they are one of the few central banks still engaged in more expansionary forms of monetary policy compared to central banks elsewhere that are tightening.
What the factors are that lead Japan to have a lower inflation than Canada is an important question that is the source of a lot of research that doesn’t have a quick or simple answer to it, I’m afraid. But all advanced economies are experiencing rising inflation rates right now even though they may have started from different levels. Those increases are really being driven by energy-related oil price factors here and elsewhere.
Senator Ringuette: The U.K. pound is diminishing. It seems that there is a beginning on the world scene to have much speculation on currency. If that happens at a greater scale, what would be the impact on inflation in Canada, from your perspective?
Mr. Tombe: Generally speaking, when the value of a country’s currency falls relative to others, then domestic rates of price increases will rise because then the cost of imported items will be higher. You are right to note that the British pound is falling, but most currencies are falling relative to the U.S. dollar. Over the past year or so, the Canadian dollar has fallen; the Australian dollar; the Euro is lower. The Japanese yen, as we noted, is also significantly lower than a year ago. I think it is down about 20 some per cent compared to a year ago.
That will, at the margin, increase inflationary pressures in those economies because imported goods will see higher prices just mechanically from the lower value of these currencies.
Senator Yussuff: Thank you, Professor Tombe, for being here today. Given the very clear, I think, research you have supplied with regard to the drivers of inflation, both energy and shelter, the bank instrument in terms of dealing with inflation it seems to me is very blunt. They are applying, of course, the only thing they have, which is the increased interest rate, which is affecting the entire economy without actually focusing on the area we need to focus on. Of course, with higher interest rates, the challenge will be how we continue to build shelter if the market doesn’t see this as the appropriate time to invest in constructing more shelter.
A while ago, you alluded to potential tools the government might use. Could you elaborate more with regard to how we can tackle this without driving the economy into recession, given the bank’s zeal to get to 2 or 3% inflation within a very short time?
Mr. Tombe: That is an important question, senator. Experts on housing policy would be better able to weigh in on what governments can do to boost overall investment in housing in order to increase supply and bring down shelter prices.
It is important to recognize that this is not a nationwide challenge. Different markets face pressures in the housing market to different degrees. Affordability in Calgary and Edmonton, for example, remains very good at about one third of income required to afford median properties here. It’s in Vancouver, Victoria and Toronto where there are particularly large affordability challenges. I would look to local governments and restrictive zoning policies, things of that nature, which prevent housing supply from increasing in those particular markets.
There may be a role for the federal government to provide financial incentives for local or provincial governments to pursue policies that ease our ability to expand housing supply, but I think it is difficult for the federal government because this is really a local and provincial area of responsibility.
The Chair: Thank you very much. I want to return, if I could, Professor Tombe, to the issue raised by Senator Massicotte and try to come at it from another way. You have also written a piece called “Canada’s not-so-Great Resignation: It’s retirements we should really be worried about.”
You say that on some level, people quitting jobs to start another or go back to school — there are many reasons — is not much higher than pre-pandemic levels. However, we’re starting to see that what is impacting this is people who have great dissatisfaction with their jobs. That seems to be the larger reason. What are your findings on that?
Mr. Tombe: That is an important question, senator. I’ll take a step back to note that in the United States — which shapes much of our narratives or impressions of underlying factors even here in Canada — we are seeing elevated quit rates where there does seem to be a much higher increase in the fraction of individuals who leave their jobs there.
In Canada, roughly 1% of workers leave their job in a given month. About half a per cent do so because they are making a job switch, where they are changing employers, and then the rest quit for other reasons. People leave for many reasons: going back to school, retirement and so on.
The percentage of individuals over the past year who have left their job because they were dissatisfied with it was about 0.7%. If we go back prior to the pandemic, the average rate of annual quits for that reason was about 0.8%. We have actually seen a modest decrease in the fraction of individuals who are leaving their job because they are dissatisfied. Prior to the financial crisis, we were averaging about 1.2% who quit for that reason.
What is particularly concerning about the increase in departures from employment is the number who are leaving because they are retiring. About 1.5% of workers over the past year left for retirement. That’s much higher than the 1% that prevailed a decade ago, and it will continue to rise as populations age.
The Chair: We’ll focus in on that question, because I think we’ll come back to what Senator Massicotte was talking about at a future time.
Senator C. Deacon: Thank you again, Professor Tombe. This is very enlightening.
We have heard that the slow exit from what are generally thought to be positive COVID supports that were provided by provincial and federal governments may have been a contributor to inflation, but not a big one. Has that shown up in your data?
Do you have any thoughts about other efforts that have been made recently by the federal government that are quite targeted, as you identified earlier, and other efforts by provinces that have been quite general, providing everybody with a bit of support? In your opinion, do those two have a different effect in terms of inflation?
My first question: Do you see in your data that the slow exit from these supports was a contributor? Second, with the more recent supports, is there a difference between those that are applied to the general population and those that are more targeted?
Mr. Tombe: Thank you for two great questions, senator. With respect to the income supports provided by governments through COVID, that would be something that would increase demand for goods and services and therefore potentially be a source of inflationary pressure.
We are seeing some of that show up in our analysis. Not all of the increase is supply-driven. Over the past year, about 15% of the acceleration was due to demand-side factors. Prior to recent quarters, demand was the dominant source of inflation — later in 2020 and in early 2021. We might be able to point to fiscal policy measures — providing income support to individuals, who took that support and potentially went out and purchased more goods and services than they would have otherwise — as an important source of rising inflation early on. The acceleration over the past year is largely a supply-side story.
It is difficult to cleanly and perfectly separate supply and demand because they are interrelated. For example, consider individuals receiving income support who are using that to purchase more goods and services than they would have otherwise — in particular, physical goods as we shifted at the margin away from services. That may be a factor clogging up the capacity of ports, for example, leading to supply-chain bottlenecks. They are interrelated issues.
This informs measures that we are seeing right now in terms of cash transfers broadly to individuals — as you noted, some provincial governments are doing that — or more targeted measures like the federal government is doing. The effect of that on inflation will depend on what people do with the money.
Federally, the boosted GST credit, for example, will go to lower-income individuals, who are the most strained from price increases. If you look at households in Canada earning, say, less than $30,000 per year, on average, those individuals are accumulating debt because consumption exceeds income. To the extent that rising prices mean that more debt is accumulated than what would have otherwise been the case, it’s plausible to suggest that the boosted cash transfers will not be spent on additional goods and services but just bringing down household debt levels — in effect, shifting debt from those individuals to the federal government. That’s a way to provide support to them that doesn’t, in my view, create meaningful inflationary pressures.
More broad support, just because it’s much larger in scale, has the potential of a larger macroeconomic effect. But because the biggest driver of inflation is global oil prices, it really doesn’t matter what Canadian federal or provincial governments do; we are not going to move the needle on global oil prices. Also, I don’t think there’s a particularly large source of concern there.
Senator C. Deacon: Thank you.
Senator Gignac: China joined the WTO in 2001. In the following 20 years until the pandemic, we have seen deflation in the goods component and an increase in the services component. Overall it was around 2%. I think the central bank had a pretty easy ride.
Now with the pandemic, not to mention the cold war between the U.S. and China, the jeux politiques, it appears to me that for businesses it’s no longer the priority to minimize cost; rather, it’s to avoid disruption, and supply-chain management is the top priority.
Do you not think it will be much tougher for central banks to bring inflation back to 2%? Does it have any implication on the neutral rate estimate by the central bank, this new environment of managing supply chains?
Mr. Tombe: Thank you for the question, senator. That’s a tricky question to answer. First I’ll start with the neutral rate, which is the bank rate that’s consistent with sustainable economic growth and inflation within the 1% to 3% target range. Estimates vary. The Bank of Canada itself has a range of estimates, but maybe it’s somewhere between 2.5% to 3% or so. What that is and how it is affected by global economic developments is an important question, but one that researchers do try to tackle and the bank is regularly updating its own estimates of what that neutral rate is. Maybe I misunderstood the question, but it was about whether or not I think there is a —
Senator Gignac: The question is do you not believe we are in a regime shift? Before the pandemic, it was globalization no matter and minimize costs, and you have no concerns even if your supplier is in China. But now, since the pandemic has highlighted that China could close their borders because of its zero COVID policy, and now the Cold War and the possibility that your semiconductor produced in China could be overnight, or I don’t know when. So now you will no longer have access if China decides to block access to them.
It appears to me that minimizing costs are no longer a preoccupation of boards of directors. It is now, how reliable is my supplier? We talk more and more about onshoring rather than offshoring. Do you understand the angle of my question more? And minimize costs if it is no longer the top priority of the companies, quite frankly, it will translate to the customer.
The Chair: Just get it there regardless of price.
Mr. Tombe: I still view corporations as managing themselves in such a way as to maximize shareholder value. Managers have a fiduciary responsibility to do so. Minimizing costs is one way of achieving that. I wouldn’t characterize the higher weight now placed on potential disruption of global supply chains as moving away from the objective of minimizing costs because those disruptions are themselves a source of cost. How to manage multinational productions and long and complex supply chains, I think that is something we have seen changing even prior to the pandemic. Global trade as a share of global GDP has been declining since about 2010, I believe. Disruptions to global economic relationships, the trade war between the United States and China, policy moves such as Brexit in the United Kingdom, the seeming aversion to increased trade agreements that we’re seeing, not just in the United States but in several countries, and even the challenges that even Canada had at getting the Canada‑European Union Comprehensive Economic and Trade Agreement, or CETA, across the finish line with Europe.
It may be we are now in a period, and have been for years, of deglobalization in the sense that global trade will matter less for overall economic activity than it has historically. I see the responses of individual companies potentially putting more weight on supply chain resilience, not as something that represents a fundamental change in how companies are managing themselves, just that we are recognizing that there are real and important risks to multinational production that are higher now than in the past.
The Chair: Thank you.
Senator Bellemare: I will follow up the question of Senator Ringuette on international perspectives. If we look at the Euro zone, you have the European Central Bank responsible for inflation. If you look at a country’s inflation rates, there is a lot of variation within countries in that zone. France, for instance, is lower. Can you explain why that is the case?
Mr. Tombe: It is the case that countries have different rates of inflation in Europe because they are subject to different underlying economic shocks. Prices can increase in one region and decrease in another depending on what those shocks are. We see that in Canada as well. Inflation rates differ across provinces and can differ a lot. I think about Alberta’s price increases prior to the 2015 and 2016 recession. Those are tied to booming economic activity from high oil prices. Other economies may be subject to negative shocks that would tend to decrease prices there.
How prices are equalized in terms of their up and down movements across economies depends on how interconnected they are. If you have two economies within Europe that trade more than two other economies, then those two more tightly interconnected economies will tend to have more strongly correlated price movements than the ones that are not connected. Trade flows matter for how shocks in one economy permeate and transmit through to another. In principle, given there are costs of trade and labour mobility, we shouldn’t expect that prices will move up and down perfectly even within the same, in this case, new economy.
Senator Smith: Professor, you talked about productivity and regulatory issues. One of the things that you suggested in a recent paper is that provincial and territorial governments should recognize the principle of mutual recognition. Could you expand on that point and give us some clarity on the exact definition of mutual recognition?
Mr. Tombe: Thank you for that question, senator. This is indeed a new paper released through the Macdonald-Laurier Institute last week that looks at potential policy approaches to improve interprovincial trade. The nature of trade costs between provinces is not explicit taxes or tariffs on goods and services that are exchanged, but differences in rules and regulations that exist in one province compared to another adds costs to businesses trying to operate or sell into both jurisdictions. There might be differences in inspection requirements or certifications of certain professions that differ.
Mutual recognition is, I think, one potentially very powerful policy tool for a province to say if it is good enough in Ontario, then it is good enough for Alberta without having to require separate certifications or explicitly abiding by Alberta’s specific rules. If provinces wish to do so, this would be a way to, in my view, eliminate most of the policy-relevant barriers to interprovincial trade. In that paper we estimate that if all provinces were to do it across all sectors, economic gains could be substantial, between a 4% to 8% increase in overall aggregate productivity in Canada, which is significant. On the scale of, at the upper end, $200 billion per year in additional economic activity.
The Chair: Yes. This committee has said that same thing repeatedly. Thank you for reinforcing it.
Senator Yussuff: On the issue of wages in with regard to current inflation, what arguments would you make or explain in regard to current wage increase and, of course, the challenge we face in trying to get inflation down?
Mr. Tombe: Labour is the most important input into the production of most goods and services in the economy. So movement in wages is an important driver of changes in production costs and therefore an important source of potential price changes. This is a source of concern that I think central banks here and elsewhere have. If people are expecting inflation to be high, then they will increase wage demands, which will increase production costs, which will lead to the price increases that people expected in the first place.
The wage-price spiral is a challenge that I think we want to avoid. That’s not to say wages cannot grow by more than the 2% inflation target that we have, but they need to grow or shrink for fundamental reasons related to either labour productivity or supply and demand for workers in different sectors at different skill levels. But wage increases that are driven by expectation of high inflation, that is quite risky.
The Chair: All right. I’m sorry, we are going to have to stop you there. Professor Tombe, thank you. On your behalf, we will table with the committee The Rise (And Fall?) of Inflation in Canada, report your comments regarding the great resignation, and also the Macdonald-Laurier report. What was that entitled?
Mr. Tombe: That was entitled Liberalizing internal trade through mutual recognition: A legal and economic analysis.
The Chair: Okay. We will do that. Thank you very much.
For our second panel today, we have the pleasure of welcoming Mr. Jim Stanford, Economist and Director of the Centre for Future Work.
Mr. Stanford, the floor is yours for a few moments of opening statements.
Jim Stanford, Economist and Director, Centre for Future Work: Thank you, Madam Chair and senators. I’m grateful for the opportunity to appear before you today. I always appreciate the efforts of the Senate to consider the major policy challenges facing our country in a more thoughtful and less partisan way. I can’t imagine a topic where that approach is more fitting and more needed right now than where our macroeconomy is at today.
Let me be direct. I think we’re at a very fragile, dangerous moment in Canada’s economic history. The evidence is accumulating that we are poised on the brink of a significant and potentially lengthy and harmful economic downturn. It may have already started, as of the third quarter of this year.
This negative trajectory is all the more disappointing because it comes right on the heels of what will go down, I believe, as one of the most successful policy interventions in the history of economic policy-making, namely, the macroeconomic rescue mission which responded to the initial COVID pandemic in 2020 and 2021. In essence, we are snatching defeat from the jaws of victory. On the heels of a tremendous policy response with proven success, we’re now going to throw it away by entering an unnecessary and self-inflicted recession.
Some of the factors in this current dangerous situation are clearly beyond our control, arising from global developments like the war in Ukraine or this week’s unprecedented events in the U.K. But to a large extent this current macro trajectory, this point of vulnerability, is self-inflicted and is the predictable and avoidable result, in my judgment, of the inappropriate application of simplistic textbook monetary policy to a situation that was never described in any economic textbook, namely, a worldwide pandemic.
The economic contraction that we experienced with the imposition of health restrictions in the initial months of COVID was the fastest, deepest downturn in Canadian GDP and employment ever. But the rapid and powerful fiscal and monetary interventions undertaken by Canada’s government and most others around the world prevented that shock from turning into a sustained recession or, more likely, a depression.
Believe me, if we had had a depression, we wouldn’t be worried about inflation today. In that regard, we have to keep these things in context.
Output and employment responded faster than almost any economist, myself included, could have predicted after those initial lockdowns. That was thanks to the spending power provided by extraordinary income supports, the stability in employment relationships that was reinforced by the wage subsidy program and, above all, by Canada’s relatively successful public health response to limit contagion, illness and death — the second best in the G7 measured by excess deaths per capita.
Since, I’ll remind you, the economy is composed of human beings who have to get up on Monday morning and go off to do their jobs, produce and generate income and pay taxes, keeping human beings healthy is the ultimate prerequisite for economic success. The idea that there was some kind of trade-off between protecting the economy and protecting health was always absolutely wrong. The fact that Canada quickly regained pre‑COVID levels of employment and output is an astounding accomplishment that we should not forget. Economists will be studying it for decades to come.
It’s often claimed that the Canadian policy-makers overdid that policy response, that rescue effort. For example, total household income in Canada actually grew during the pandemic lockdown. Surprising, because new income supports more than offset the loss of employment income at that time. I reject the argument that was a mistake. The interventions made and the subsequent trajectory of GDP and incomes measured before taxes and before subsidies are not independent from each other. The fact that those interventions were made explains why the economy rebounded quicker than expected and why incomes before those subsidies ended up being more resilient than expected.
The same goes for arguments that the Bank of Canada somehow overdid it with its monetary stimulus. The economy turned out to be far stronger than expected at the beginning of the pandemic, but that was not an error in forecasting. That was the result of the rescue effort. It’s not that the Bank of Canada could not have foreseen the rebound in GDP, employment and spending. It’s true they couldn’t have. No one had a crystal ball that could have predicted what happened during the pandemic. The bigger point is that it was the bank’s own actions, supplemented by fiscal support, that helped achieve that rebound and meant that the economy is in relatively good shape coming out of the pandemic.
Now that all those unprecedented events should be reflected in ongoing disruptions and challenges should be no surprise, given what’s happened. Chief among those right now is the acceleration in inflation we’ve seen in the last year. Claims are made that this inflation is somehow the personal responsibility of our Prime Minister or of the Bank of Canada “printing money.” That is outright crude misinformation. The acceleration in inflation that we’ve seen is a worldwide phenomenon. It clearly reflects unique pressure points arising from the pandemic, including disruptions in supply chains, difficulties in international transportation, the reallocation of consumer spending away from services and toward certain categories of goods and then the energy price shock we’ve seen after the Russian invasion of Ukraine.
In particular, there is no connection between the size of a country’s deficit and the rate of inflation. There are countries that had bigger deficits than Canada, like Japan, but have much lower inflation. There are countries that had smaller deficits than Canada, like Germany, but have higher inflation. The problem we now face is that central banks around the world, including the Bank of Canada, are feeling bruised by the criticism they’ve received by overdoing the stimulus. As a result, they have rediscovered their true religion and are inappropriately, and to an extreme, applying textbook remedies to a problem that is not what is described in the textbooks.
The reality is inflation has many potential causes, not just an overheated level of aggregate demand or an overheated labour market. The economic evidence in Canada suggests those factors are subsidiary or secondary if relevant at all. Our domestic demand is not overheated at all. There were many signals, even in second-quarter GDP data, that demand is not unsustainable and, in fact, weakening in many areas.
As for labour markets, despite the historically low level of unemployment we’ve seen real wages falling, nominal wage growth lagging inflation, there’s no evidence that this is a wage‑price spiral in any regard. There is evidence that company profits in Canada have widened during the current inflationary episode to their highest share of GDP ever. If we want to look at where the spiral is starting, we should be looking at the business side of things, not the workers.
We’re just starting to see the impacts of the rapid increases in interest rates. We’ve seen falling asset prices, falling real estate prices and higher household debt service, but it’s going to get much worse. We will see unintended and unpredictable effects of higher interest rates based on knock-on relationships that are impossible to predict. We saw some of that in the U.K. this week and we’ll see a lot more as higher interest rates, higher debt service charges and falling asset prices interact in a dynamic and dangerous cycle that will impact household and financial stability.
I think we have to be more nuanced and more open‑minded in understanding the causes of current inflation and more multi‑dimensional in our response to it, including protecting lower‑income Canadians against its effects while we address its true causes.
I’ll leave it at that for opening, senator. Thank you, and I look forward to our discussion.
The Chair: Thank you very much for your opening remarks. We’ll begin our questions with Senator Deacon.
Senator C. Deacon: Thank you, Mr. Stanford, for being with us today. You said you thought that excess demand from the COVID support that was provided contributed to the rebound. To what extent do you see evidence that it contributed to increasing inflation?
In terms of it not being foreseeable by the Bank of Canada that this rebound would be there, what about the fact that the money supply was at an all-time high by many multiples leading out of the early stages of the pandemic? That is, looking backwards.
Looking forward, I perceive that you’re suggesting the Bank of Canada should, at the very least, pause interest rate rises. Is there any concern for the bank to be worried about a potential weakening Canadian dollar as a result of the inflationary pressures of that?
Mr. Stanford: Thank you, senator. I spotted three distinct questions there, and I’ll look at them in order.
In terms of the role of income supports, the payment of CERB benefits and all the other emergency income supports, as well as the wage subsidies that were paid to employers, supported household incomes through the pandemic and in fact in aggregate, not for each individual, household income actually grew during the pandemic, which is counterintuitive and it shows that that was a powerful and fast response.
The fact that it grew is not just because the income supports were paid, it’s also that employment income and other market income didn’t fall as much as anyone would have expected given what was going on. Those two things together account for the rise in total income.
That occurred at a time when you couldn’t go out and spend. Retail shopping was limited. Obviously, hospitality and travel opportunities were eliminated. With more money and less to spend it on, Canadian savings accumulated. We did have a period of several months where household savings rates were astoundingly high, and there is this package of money that’s waiting to be spent. We have seen some of that happen since the reopening.
However, savings levels in Canada are still elevated relative to their pre-COVID norms. Consumption, if you look at the trend, has still not regained its pre-COVID path. In other words, given the time and population growth that we’ve experienced, real consumption spending by households is not overheated at all. In fact, it hasn’t even caught up to where it would have been without the pandemic.
I think the income supports played a role, for sure; and if they had not been there, then Canadians would have lost jobs, would have lost homes and wouldn’t be able to spend today no matter what, and inflation would be lower. Make no mistake about it. Inflation would be lower.
Inflation was much lower in the Great Depression. In fact, we had deflation. In that regard, the focus on inflation has to take account of the broader macroeconomic picture, including the successful stimulus from both the government and the Bank of Canada.
In terms of the money supply, I think there’s a lot of misunderstanding about the money supply and its relationship, first of all, what determines the money supply and its relationship to overall economic activity.
Certainly, the Bank of Canada’s footprint in the overall money supply grew because of the use of quantitative easing, balance sheet purchases to pump spending power into the economy. But overall money supply, remember, depends mostly on credit created by the private banking system, not by the Bank of Canada. This is how it works in a credit money system where the dominant players are private chartered banks.
Part of the reason for the Bank of Canada’s actions was the expectation that private money supply creation, which happens when banks issue loans to new customers, was going to contract. Initially, it did contract. The increase in the money supply was not primarily because of the Bank of Canada’s asset purchases. The increase in the money supply was because private bank lending ended up being more resilient than expected, in part because of this huge and ultimately unsustainable boom in mortgage lending.
In terms of the Bank of Canada pausing its interest rate hikes, I will note the Bank of Canada has been among the most aggressive of any central banks in the world in increasing its interest rates fast and steep. I think that a pause is certainly in order. That would still put us ahead of the pack of most other central banks, certainly in Europe, Britain and Japan in terms of the scale of monetary tightening that is happening.
I think that we have to stop and look at what’s happening. I think Canada’s economy is likely already shrinking. Employment has declined for three months in a row, and that has never happened without a recession in the past.
The impact on the dollar, the dollar has already weakened. Everyone’s currency, other than the U.S., has weakened because of what’s happening globally with this tightening. It’s going to be just the beginning of much more. I don’t think the weakening dollar itself is our main problem.
Senator Bellemare: What would be your suggestion? If we don’t use monetary policy, what tool would you use to permit Canada to go through this turbulence in the price system?
Mr. Stanford: Thank you, Senator Bellemare. I thought your writing on this topic — which I’ve reviewed for years, but before this hearing as well — have been very informative and useful. Thank you.
Monetary policy clearly has a role to play. I’m not saying that monetary policy should do nothing. I am saying that monetary policy should be more cautious, more open-minded and more nuanced.
The assumption that seems to be built into the tightening response by the Bank of Canada, and other central banks, that inflation is arising from an overheated domestic spending profile, I think that assumption is wrong. That is not the primary cause of the inflation that we’re experiencing. Obviously, it comes from the supply side more than from domestic demand. It’s imported for the most part. And domestic interest rate hikes are going to have no direct impact on it.
Now, domestic interest rate hikes can clearly bring inflation down, they absolutely can. If we create a recession in the domestic economy, which will help to offset the price pressures arising from other sources. But I think that’s kind of a hollow victory.
I do think monetary policy is relevant. I think it could be more nuanced, first of all, in terms of how it’s applied. It doesn’t have to be a one-size-fits-all increase in interest rates across the board. We can use prudential lending requirements and other financial regulations to try and restrict the flow of credit in places that are less useful, such as fuelling the property price expansion, and while preserving the flow of credit to things that are useful such as real, productive investment by businesses which, by the way, is required in order to meet those supply chain disruptions.
In this regard, high interest rates in their own right are counterproductive, because they disincent businesses to invest in new capital. We need new capital. We need new supply. We need improvements in our infrastructure.
I also think that the fight against inflation can’t just be assigned to monetary policy and the Bank of Canada. I think the government has a role to play in its fiscal policy, its labour market policies and its social policies.
This is where I think a more multi-dimensional and multi‑partite approach to managing the problem to address its true causes, not its assumed causes from a textbook in which inflation always arises from unemployment falling below its NAIRU, or non-accelerating inflation rate of unemployment, magic spot but, rather, the actual causes of inflation we see today and protecting Canadians, those who need it the most, against its effects while those true problems are addressed.
Some of it will fix itself, that is obvious. There are many indications globally that some of those initial causes of inflation are retreating: international shipping costs, energy costs in some areas, agricultural costs. Some of this will be a question of waiting. Throwing the economy into a recession because we have to prove that we’re tough on the inflation target doesn’t seem like the appropriate course.
Senator Loffreda: Thank you, Professor Stanford, for being with us today.
I’d like to lean into what you just mentioned, where to fight this inflation. The government has a large role to play on the market, labour, social and labour market policies.
You did mention, and you are pessimistic on the economy; you said it’s going to get much worse, unintended results, unpredictable. You disagree, obviously, with the current monetary policy. You did mention it’s not demand-driven. Consumer spending is not trending to pre-COVID levels, nor is demand, and you would pause the interest rate increases.
I’d like you to elaborate further. What type of policies? If there are a few quick wins this morning, a few recommendations, observations we can make, what would those be for the market, labour market, social market policies and the role the government can play?
On a last note, very important, is with respect to the Canadian dollar, we’ve seen the strengthening of the U.S. dollar and the feds and their monetary policy. You did mention let’s halt or put a pause to the interest rate increases.
Statistics change constantly, but the latest numbers I’ve seen are over 80% of Canada’s GDP is import export. We are a trading nation. We’ve talked about the imports. But the exports are so important to our economy. Would that be an opportunity, where greater than 40% of our GDP is exports, three quarters to the U.S. market? We talk about deglobalization, but would that be an opportunity?
I’d like to add some positive to all the pessimistic remarks and a bold prediction; how long do you see this cycle lasting?
Mr. Stanford: Thank you, senator. In terms of what government can do regarding inflation, I don’t know if there are quick fixes in this area, but I think there are some important fixes that we should be looking at.
The first would be to address some of the key causes of the inflation upsurge that we’ve seen with fundamental measures to make us less vulnerable to those sorts of price shocks in the future. I’m thinking particularly of the energy price shock, which has arisen from global oil prices first and foremost, after the invasion of Ukraine.
In a way, this is par for the course, given how global oil futures markets operate. Any time there’s a perceived shock to expectations, it doesn’t have to be a disruption in actual supply. There hasn’t been a disruption in oil supply because of the war in Ukraine. In fact, global oil supply, including supply from Russia, has increased, not decreased, since the war. It’s more about expectations in that highly financialized market driving spikes in prices, and we have organized our energy market in Canada so that those prices are reflected in what we pay at the pump here, even if it’s gasoline that was refined from oil produced in Canada and distributed in Canada, we’re still paying more for it. That’s how we’ve organized the energy market.
Another key source of recent inflation, of course, was the housing bubble. Property prices are starting to decline now, but that doesn’t mean housing inflation will necessarily decline. Our CPI takes account of housing through the cost of servicing a mortgage, not the price of the property itself. Ironically, we can see an increase in housing costs, as captured by the CPI, from higher interest rates.
Same goes for rents, which tend to go up when interest rates go up and housing prices fall, as more people have to rent because they can’t afford to buy a house anymore.
Addressing those two factors, energy price inflation and housing price inflation. On the energy side, I think we need to accelerate the transition to renewable energy, which is insulated from those global speculative shocks in world oil futures markets. We need to accelerate a program of affordable housing, including big expansions in supply of non-market housing of all sorts, such as co-ops, public and social housing, community housing trusts and others. Neither of those are quick fixes. Both of those are fundamental problems to address weaknesses in how our economy depends on speculative markets.
A quicker fix would be the use of price controls by various levels of government in both of those key areas. Price controls have a bad name. You somehow sound like you’re talking about Soviet central planning, but in fact, we have price controls in many areas of our economy. Most energy prices in Canada are directly regulated, and it’s not entirely clear that we can’t directly regulate petroleum product prices as well.
The reality is, the largest single source of inflation that Canadians are experiencing is an increase in the price of petroleum products, including gasoline. Again, that has been reflected totally in record profit margins in private energy companies that are producing those commodities here in Canada. It has nothing to do with Putin or Ukraine. We’re paying more for it because of huge profit-taking by those companies. We could absolutely — and other countries around the world are looking at this — find ways to limit the upsurge in petroleum prices more directly with price regulations.
Failing that, you could tax the excess profits that are being collected by those companies and use the proceeds to support protective measures or counteracting subsidies for lower-income Canadians.
Senator Yussuff: Thanks, Professor Stanford, for being here today. You have mentioned that the governor of the bank has certainly encouraged large employers, that he was speaking to recently, not to support major wage increases for workers who are worrying about the spiral, making inflation worse.
What would be the impact on continued interest rate increases on the long-term prospect for workers and their standard of living going forward?
Mr. Stanford: Thank you, Senator Yussuff. I was, in a way, disturbed by that particular reference that the Bank of Canada governor made before a business audience, saying not to sign wage contracts that allow wages to keep up with inflation. I thought it was inappropriate. I think the bank has tried to clarify the meaning of that intervention, but I think it does reflect a deeper-seated bias in the formulation of monetary policy that we have to worry about wages — gosh, we have to worry about wages — but we’re not going to worry about the other slices of the economic pie. In particular, we’re not going to worry about profits.
I have never seen — and I’ve looked. I’ve looked through the Bank of Canada’s Monetary Policy Reports and the speeches of the governor. I have never seen the Bank of Canada make a reference to profits being too high and that’s causing inflation. But if you decompose where the revenue associated with higher inflation in Canada is going, it is going to profits. The profit share of GDP has increased during this inflationary episode to the highest level ever. Real wages have declined. The labour share of GDP has declined. The temporal timing of wage increases lags well behind the uptick in consumer prices.
So this obsession, which I date back to people reading textbooks about 1970s inflation and assuming that’s what inflation is about, this obsession with the wage-price spiral is quite misplaced. I think it is not just analytically erroneous; I think it reflects a bias in terms of the priorities that monetary policy-makers are putting. They somehow accept profits as normal or natural or healthy, even big wide profits that are clearly correlated with rising price inflation.
I think the assumption that wages must be suppressed to bring inflation down is both unfair and economically wrong. Workers did not cause this inflation. That is absolutely clear in the data. By saying that wages must be suppressed below current inflation in order to solve current inflation means workers will pay twice. We’re punishing the victims of inflation in order to solve a problem that they did not cause, and then we’re turning a blind eye to the true causes of the problem — that is, both the supply disruptions and global energy price shocks that I’ve discussed — but also profit-taking right here at home. There’s a small group of Canadians who are profiting like they’ve never profited before from the current rise in prices.
Saying all Canadians are paying because of inflation is plain wrong, and I think monetary policy needs to take account of those distributional consequences of both inflation and the responses to inflation.
If we now throw the economy into a recession, which seems likely, in order to bring down inflation by, first and foremost, reducing wages even further below current inflation, then we will lock in the decline. Canadian workers, on average, have seen a decline of about 4% in their real wages since this inflation started. We will lock in that decline. We won’t give workers a chance to recoup what they’ve lost from inflation that they didn’t cause and likely cause an even further distributional shift away from workers toward the owners of businesses.
I think that’s unhealthy economically and politically. We’re seeing incredibly worrisome developments around the world with the rise of extremist or anti-democratic political sentiments and movements, obviously reflected most recently in this election in Italy, and we have those challenges right here at home in Canada as well. The idea of hundreds of thousands or millions of Canadians being thrown out of work to bring down an inflation problem they clearly didn’t cause when their real standards of living are in jeopardy I think would create an incredibly fertile environment for those dangerous ideas to grow further.
Senator Massicotte: Thank you very much for being with us this morning.
I’m trying to understand the difference you have with the Bank of Canada. My summary would be that they see a serious detriment, a serious concern to our economy if we don’t get inflation under control as soon as possible. They’re negative on inflation and its consequences for society. I don’t think it’s a misjudgment; I think that’s how they feel about it. Could I have your comments on that?
Secondly, if we let it be and the Bank of Canada proceeds as they propose, what are your recession numbers? Will it be a 3% or 4% negative recession? Or would it be 0.1 or 0.2 of a negative? Give me a numbers sense of what the consequence would be if it continues as we so expect.
Mr. Stanford: Thank you, senator. Those are both excellent questions.
In terms of the importance of getting inflation under control, I certainly accept that inflation and rising inflation is a problem. It is one problem among many. I think part of the issue here is the Bank of Canada sees it as the biggest problem, a problem that they, and they alone, have the responsibility to solve.
That is not consistent even with the Bank of Canada’s own official revised mandate negotiated with the federal government just a year ago. That mandate makes it clear that inflation is an important priority, but not the only priority, for the Bank of Canada. It has also instructed the Bank of Canada to aim for maximum employment consistent with stable inflation.
In my judgment, I don’t think the bank’s actions in recent months have been consistent with that mandate. I think they have clearly and needlessly threatened future employment levels because they’ve made inflation their top priority or, perhaps, their only priority.
Inflation is an issue. We should aim to bring it down. Single‑digit inflation is 7% and falling in Canada. Single-digit inflation is not the end of the world. It is not hyperinflation. It is not a one-way track to the Weimar Republic as some commentators have suggested. It is a problem, and it should be addressed, but it has to be addressed by looking at the other problems we face, including the risk of a recession, which I think would be a medicine worse than the disease.
In terms of the depth of a recession, I’m worried, frankly. I do not think that if there is a recession, it will be short and sweet. As I read the Bank of Canada’s statements, it is clear they are not going to stop what they are doing just because the economy goes into a recession. It is clear that inflation, caused primarily by supply chain disruptions, global energy shocks and other imported factors, is not going to rapidly disappear just because we go into a recession.
The U.S. Federal Reserve has made similar comments that they are not going to be stopped from what they are doing by a recession.
In that regard, we could actually see continued monetary tightening even as evidence emerges of a recession having already begun. That would make it a long and painful recession, not a short one.
Unless we have a change in course by our central bank and others around the world, I would anticipate a severe recession that lasts for two or more years.
Senator Massicotte: “Severe” means minus 3% or minus 4%?
Mr. Stanford: In terms of the decline in GDP, the cumulative decline in GDP could certainly be minus 3%. That would be a severe recession. Three per cent doesn’t sound like a lot, but compared to other recessions we have experienced in the past, that would put us on par broadly with the recessions we experienced in the early 1980s — which were also a response to monetary policy shock — and the early 1990s. So 3% is a severe recession.
Senator Marwah: Thank you, Mr. Stanford. That is very interesting.
I agree with a lot of what you have said. To repeat, there is the very successful policy intervention by the government, and there was astonishment that employment levels reached pre-pandemic levels so quickly. This is not a domestic demand issue. It is not overheated. Labour markets are not in a wage spiral increase.
Where I’m hearing disagreement is you think monetary policy, specifically interest rates, have risen too quickly and too much. We can debate that, but I don’t think I hear you disagreeing that they needed to increase. I think where you’re disagreeing is the speed and amount. Correct me if I’m wrong on that.
Then we come to the fiscal measures. You say they should be more targeted. If you look at the budget response, the policy response, whether you take the GST credit the government is imposing or whether you take many of the policy measures in the Budget Implementation Act or Bill C-30, they are very targeted, including to the extent they have put a tax on banks for excessive profits. Barring a tax on the oil and gas companies for excess profits, I don’t see what policy measures you would think should be increased.
Let’s get down to specifics. What else do you think the government should do or what policy measures should be put in place?
Mr. Stanford: Thank you, senator. First of all, in terms of whether interest rates should increase or not, interest rates were near zero. They were negative in real terms, and clearly that cannot be the case forever. The fact that interest rates were so close to zero for most of the last 13 or 14 years, since the global financial crisis in 2008-09, is a sign of deeper structural issues in the economy and showed the limits to counter cyclical interest rate policy as a way of stimulating the growth that we need in bad times, let alone controlling the inflation we experience in situations like today. Clearly, interest rates had to be normalized at some point and in some way.
My concern is rather than treating it as just a big one‑dimensional sledgehammer, can we think about ways that monetary policy could be more nuanced and more targeted, including differential interest rates for different purposes or the use of financial regulations to limit credit creation, especially in areas we don’t want, instead of hitting everyone with higher interest rates?
On the fiscal measures, I agree with you that the supports that have been announced, such as the expanded GST tax credit or the Canada Housing Benefit for low-income renters, are very targeted, very important and very beneficial. The argument from some, that somehow that’s going to add fuel to the fire of inflation, I don’t accept for a moment, because they’re so targeted and they’re small, particularly in contrast to the overall direction of fiscal policy, which is an enormous tightening.
Canada’s federal deficit is shrinking rapidly because the income supports which were implemented during COVID have been phased out. The overall impact of fiscal policy right now is tightening, not stimulating. So fiscal policy is clearly not inflationary.
I would argue that we need more supports for those low-income earners. I would argue that governments at all levels, not just the federal level, should be supporting wage increases to keep up with inflation so that real spending power of workers is maintained.
I would argue, especially because we are now heading into a downturn, direct government investment in infrastructure and human and caring services, such as the rollout of the early childhood education program, are more important than ever and should go ahead, because we are going to need the jobs and spending power that come with those programs in the months ahead.
Senator Gignac: Welcome to our committee. As an economist, I share your concern and analysis regarding the fact that companies have used their purchasing power and exaggerated too much since we have very record profits.
My topic is this: It is more the reaction of government and the G7 on the fiscal side, because inflation affects poor people more than rich people. How do you rate Canada compared to other G7 countries in terms of reaction to help people with different evoke some measure? Do we have some things that we have not done in Canada that we could have done or that we could do and that you see other countries do, rather than just thinking about maybe pricing controls like Trudeau’s father, assuming there is not big appetite for that? Other than price controls, are there other things the Canadian government can do to help people with inflation?
Mr. Stanford: Thank you, senator. That is a good question.
I will say outright that I have not studied the G7 responses in detail. First of all, on pricing controls, some of the G7 economies are looking at pricing controls as well. We even have some of them in Canada. I’ll make reference to rent controls, which are in place in several places in Canada, which actually will play an important role in stabilizing rent levels as interest rates increase. Here in British Columbia, the provincial government announced a 2% cap on rent increases. That is a direct price control that will make a difference to the CPI. I think pricing controls have to be considered, even though they have a bad name from Trudeau the elder’s days.
In terms of fiscal responses in other countries, we have seen several countries in Europe implement excess profit taxes on the energy sector in particular, and then use the funds to redistribute toward income supports or price subsidies for lower-income households that have been negatively affected by energy price inflation. In the U.K., for example, even before the current government, they had the excess profits tax and had announced energy price subsidies. In continental Europe, that is quite widespread.
In terms of more specific or targeted measures, I would have to do more research on what has been announced in G7 countries lately.
One thing we can learn from other industrial countries, particularly in Europe and to some extent in East Asia, Japan and Korea, would be the importance of what we might call labour market planning or, perhaps, sector-wide labour market partnerships to stabilizing the relationship between wages and prices that many have expressed concern about.
In particular, when you have a very strong and centralized or coordinated system of collective bargaining and wage determination — as you see, say, in the Nordic countries or some continental European countries like Germany — you can set wages on an ongoing, long-run basis in relationship to real labour productivity growth and labour market conditions so that wages remain healthy even during weak times and then don’t get out of control during times of lower unemployment.
This is an important lesson for how to try to maintain a macroeconomic condition of very low unemployment, which would be a kind of wages planning strategy involving sectoral or economy-wide partnerships — or corporatism, as it’s sometimes called — to set wages at a level that is healthy but sustainable. That, in a way, takes some of the pressure out of this concern of central bankers that if unemployment falls too low, then a wage‑price spiral will unfold. This is the argument we are hearing today. I think it is not appropriate today, but it is an argument we hear today.
One way to prevent that is to have wages set deliberately. Rather than on the basis of market power at any given point in the labour market cycle have them set in a more coordinated and institutionalized way. That is an important lesson we could learn from Europe and East Asia on this score.
Senator Loffreda: To continue on my previous question, we’re on a good trend talking about energy and price controls, with further price controls on food and essential supplies. I asked you to make a bold prediction. You are predicting a severe recession, minus 3% over two years.
One area you didn’t touch on is the effect on the Canadian dollar with respect to monetary policy. You wouldn’t worry so much about a weakening Canadian dollar if we halt interest rate increases? As I mentioned, 40% of our GDP is exports, three quarters to the U.S., so that would create an opportunity.
Could you provide a comment on that, as well as how we could avoid a severe recession? You have been doing very well on that thus far and I find it very insightful. Do you have any further comments on how we could avoid a severe recession, minus 3% over two years, besides the monetary policy? As you mentioned, the Bank of Canada and global central banks are keen on continuing the restrictive monetary policy, although there might be weakening demand and a weakening economy.
Mr. Stanford: Thank you, senator. I’m sorry I didn’t get to your trade question in the first go-round. It’s very fitting and I’m glad I have a second chance.
In terms of price controls in the food and grocery sector, or other essential items, it is very difficult to contemplate directly how that would happen, given the immense diversity and volatility of the things people buy in a typical grocery or hardware store. I think price controls have their greatest potential when they’re applied to fundamental inputs that are across the economy and somewhat homogenous, so energy prices. This is why we regulate natural gas and electricity prices — in part because of the monopoly power of utilities but in part because of how essential they are as an input to everything else that we do. I do think there is potential for regulating gasoline prices, for the same reasons, as well as housing, as I mentioned, the rental issue.
In terms of the effect of the Canadian dollar, you are right that the decline in the Canadian dollar would have some beneficial impacts in terms of the real trade flows back and forth in our economy.
I’ll give one note of caution regarding the statistic of about 80% of our GDP being tied up with trade. Just taking the total gross value of exports and dividing it by GDP is somewhat misleading. That would suggest that about 25% of our GDP depends on exports. In fact, if you net out the inputs that go into those gross exports, the actual value-added component of exports is quite a bit smaller than that.
Nevertheless, exports are an important driver of our economic progress and would in some ways be helped by a lower dollar. Right now our dollar is at competitive levels. It is close to its purchasing power parity level. I wouldn’t even say that our dollar today is low. It could go lower and probably will go lower in the course of the next year or two. That would, if anything, stimulate real exports, and that would be helpful.
On the other hand, it makes imports more expensive. To the extent that exchange rate movements are reflected in final import prices paid by Canadians, the lower dollar can increase some of the inflationary pressures. I have looked at this somewhat, and the data in Canada suggests that the exchange rate passthrough effect is quite modest, quite muted. So I don’t see a lower dollar leading to much of an increase in import prices paid by Canadians, although there will be some.
How else to avoid a recession? Given what’s happening on the monetary policy side, I believe that, as I mentioned, the government’s commitment to actual investments in either capital or current services — capital in the form of infrastructure improvements, which we are going to need a lot of to address the supply chain issues. I’m in Vancouver, and the ports and airports here have had their issues. These are things that can be invested in. Again, it is not a quick fix, but this will improve both the resilience of our infrastructure in the long run as well as create work and income opportunities that I think will be needed as our economy enters a recession.
The same would go for some of the public services and human and caring services. I mentioned child care but also the dental care initiative and other improvements in our health care system. These are things that directly contribute to the quality of life of Canadians and then, at the current time, will have a counter-cyclical value in creating new jobs and income opportunities as the rest of the economy weakens.
Senator C. Deacon: Thank you, Mr. Stanford. One of the options I haven’t heard from you and that I would like to ask you about is with regard to our oligopolistic culture in Canada and whether the objective of increasing competition in many industries might, through legislative and regulatory changes, level the playing field and allow for new entrants who are perhaps more efficient and innovative and effectively encourage our incumbent businesses to be delivering higher value to their customers through this period, through innovation and price competition. You haven’t spoken about that and I wonder what your perspective is on that issue. Thank you.
Mr. Stanford: Thank you, senator. That is a really important point and a whole other area of longer-run structural changes that could help to, in a way, insulate Canada’s economy against these sorts of price shocks in the future. Again, it is not a quick fix. Of course, implementing competition policy reforms will take time, and then the economic response to those reforms would also take time.
I think there is a role for understanding market power and how it has contributed to the current situation. We have seen an increase in profit markups in several sectors of the economy associated with the current inflation. That suggests to me that companies are exerting some market power to take advantage of the current situation, including a combination of supply-chain disruptions, on the one hand, but also strong consumer spending power because of those income supports and excess savings that we spoke about, on the other hand. Those two together have created a recipe where companies have jacked up prices clearly above and beyond what has been required to cover their own input costs — grocery store chains being an obvious example, telecommunications being another obvious example, perhaps some in the banking system. An oligopolistic structure, where a small number of very large companies have that much power, has clearly been part of the problem.
There are ways to address that. A proposal has been made to conduct a review of grocery store operations and pricing, for example. I think that would be helpful in shining a bit of light on that.
Another area where competition policy could play a role is in the labour market. We have a situation where major employers or chains of employers — think about a franchise, where each franchise may be a separate business technically, but the overall operation, like Tim Hortons, for example, is enormous. We have anti-competitive practices in the labour market, such as no‑poaching agreements between franchisees, and other things that have helped to keep wages artificially suppressed in the past. That’s another area where I think competition policy reforms would show some promise.
Senator C. Deacon: Specifically, there has been a move on monopoly power restrictions. Ontario has brought in efforts, and we have seen it federally. Federally, we have seen a real push in the last budget with a number of elements brought forward and a commitment to do a wholesale review of the Competition Act.
We are also seeing it in open banking implementation. So there are movements we are seeing. Are you seeing more that could be done? Thank you.
Mr. Stanford: Yes. I recognize senator, there have been some efforts to look at the competition rules regarding changing employers. I think that is going to be important. I’m not an expert in competition policy, so I would have to promise to look into that and consider some of the options.
I do think, to some extent, that competition policy has a lot of promise as a longer-run response to the shift in power and income distribution toward businesses that we have seen over the last year.
Senator C. Deacon: Thank you.
The Chair: I have a quick question here. I think historically we have seen in this country the unintended consequences when we seek legislative or regulatory responses to a current problem. It is the exiting that becomes impactful and problematic. So when you talk about things like price controls or targeted interest rate policies, what would be the trigger to undo that activity?
Mr. Stanford: I think that’s a very fair question, senator, thank you. It would require getting into the weeds of how those policies would be designed.
In terms of price controls or excess profit taxes, I think it would be pragmatic to establish thresholds in terms of how fast prices can increase, for example. In that regard, there is a built-in trigger. The price control only comes into effect when prices are increasing beyond the threshold. That’s sort of what happened with the British Columbia rent cap that I mentioned earlier.
Same for excess profits taxes if it was defined with a threshold rate of return, for example, on companies being allowed to make up to twice the normal long-run return on equity in an industry like energy, beyond which a graduated excess profits tax comes into effect. It is almost like the sort of progressive income tax system that we have but applied to businesses.
There is a lot of concern with unintended consequences, of course, and there should be. Before we implement policies, we need to think through how they can be interpreted or gamed or evaded by different agents in the economy. That’s important.
On the other hand, we shouldn’t be paralyzed by concern about unintended consequences into not responding to urgent problems we see before us. That’s often, in my experience, how concerns with unintended consequences are often used, to say we can’t do anything because there will be unintended consequences. I think that is just as wrong as jumping head first into a policy reform without thinking through how it could be ultimately experienced.
The Chair: Thank you.
Senator Bellemare: Mr. Stanford, as Director of the Centre for Future Work, do you have a suggestion for us and for the provinces who experience a lot of labour shortages, where vacancies are higher than the number of unemployed in some sectors? It may not be that in the future if we are in recession. But in medium- and long-term perspective with the demographic trends, what would be your advice?
Mr. Stanford: That’s a great question. We could have a whole meeting on that topic. First of all, I’m very cautious about using the term “labour shortage.” I know employers use that term all the time. I don’t think we have run out of workers in Canada’s economy at all. We still have official unemployment. More important, we have disguised pools of underutilized labour in underemployment and part-time employment, in people who would be willing to work if there was a way to find appropriate work in a way that fit their lives, including disadvantaged groups like Canadians with disabilities and racialized Canadians and so on; people that don’t get a crack at decent jobs in the labour market until the unemployment rate is very low and employers are a little bit desperate.
I prefer to turn the question around. If you had a commitment to sustained full employment where everyone who was willing to work knew that they could in a decent way, then you would always have vacancies exceeding the number of unemployed workers. That’s a healthy thing. That would force employers to allocate labour in the most efficient ways possible, when workers actually have a choice about where to work rather than taking the first job that comes along.
The other point you alluded to is that this labour shortage is not going to last. We are heading into the opposite.
Ways to address the labour shortage would include supports for labour-force participation including from those marginalized groups I mentioned, including from women. The early childhood education rollout will assist in that. I have suggested that several hundred thousand — three quarters of a million additional female labour force participants could be arising from the rollout of universal public child care. That’s a huge support.
This wage regulation issue I mentioned in response to the earlier question where we set wages and benefits on a planned, systematic way rather than a market power moment to moment battle of the fittest would also help to stabilize labour market outcomes in conditions of low but sustained unemployment.
The Chair: Thank you for that.
Senator Yussuff: The last question, Mr. Stanford. Given the data that has been coming out in the last couple of months about the weakening labour market; obviously, the impacts are not universal across the economy. Different sectors are being impacted. What do you think the long-term trend, especially for women and workers of colour in regard to the recession should it bite much deeper, how is this going to impact women and workers of colour?
Mr. Stanford: Unfortunately, the labour market is a very unfair place and groups that are historically disadvantaged tend to be the last hired and first fired. I just referenced that to people with disabilities finding decent work and racialized Canadians who have to overcome discrimination and job ghettoization in order to obtain decent work.
One of the benefits of very low rates of unemployment is those people get a much better chance. Any of the members of the committee who have young adult children trying to find their way in the labour market where until a couple of years ago they figured their whole career would be one short term gig after another. Suddenly when the unemployment rate is very low, young people and other groups have a much better chance of finding decent work. This is one of the reasons we should prioritize keeping the unemployment rate low as our central macroeconomic goal.
In reverse, when we go the other way, those groups are going to tend to be the first ones disposed of partly because they are more concentrated in non-permanent jobs, part-time work, casual positions, temporary jobs so they are more easily dispensed with. They also tend to work in industries like hospitality and retail trade that are more cyclically vulnerable in the current state of affairs. I believe that the recession, apart from the aggregate harm it is going to impose, will have disproportionate impacts on those who can afford it the least, which is one of the reasons I’m so disturbed by the way we are heading.
The Chair: Thank you very much for your participation today, Mr. Stanford. We appreciate that contribution and your answers to a wide range of questions today.
Just for the benefit of the senators here, next week on both our days we’ll be dealing with Senator Moncion’s private bill on funding for French universities. Then we go into Thanksgiving the following week where we turn to our agenda as planned, just for your planning purposes.
Again, thank you, Mr. Stanford.
Mr. Stanford: Thank you very much.
(The committee adjourned.)