Prices are rising as the pace of economic growth slows. You know what this means: stagflation.
We experienced the last stagflation about 40 years ago. It was a combination of double-digit inflation and interest rates paired with stagnant economic growth and high unemployment.
Stagflation is back, or at least the risk of it being, some experts say. It should make you shiver if this is true.
Unlike the decade of stagflation-related unrest that lasted from the mid-1970s and early 1980s, unemployment is now relatively low. Inflation is less than half of its peak in the decade of stagflation. The wealth of Canadian households is near an all-time high. And corporate balance sheets are healthy and earnings are healthy.
Certainly, there is some justification for the growing concern in some quarters about another episode of stagflation on the horizon.
At 4.4% in September, Canada’s inflation rate hit an 18-year high.
And economic growth, at an annual rate of just 2% in the third quarter, was well below optimistic forecasts last spring.
Food price inflation has stood at around five percent in recent months. That adds about $ 700 to the annual grocery bill for a family of two adults and two children.
Inflation is consistently higher in the United States, our largest trading partner. At 6.2% in October, US inflation hit a 31-year high. On November 10, US President Joe Biden declared beating inflation to be his top priority.
Today’s price inflation is due to soaring energy prices; supply chain bottlenecks; labor shortages; the risks of the ultra-contagious Delta variant of COVID-19; and poor harvests due to floods and drought in major food producing areas caused by the climate crisis.
This is more than enough to scare forecasters of stagflation.
The fear of permanent inflation explains the surge in commodity prices this year, which many investors see as a hedge against inflation. Soaring oil, gold, and cybersecurity prices, the latest perceived protection against the power of inflation to destroy the value of money, all benefit from its moment in the sun.
“A hot vax summer risks drifting into a winter of discontent,” Bloomberg economists Bjorn Van Roye and Tom Orlik say. “With millions of people still out of work and high inflation, central banks face lean stagflation.”
The Bank of Canada (BOC) and its central bank counterparts seem to be in a bind.
Are they raising their key rates to curb inflation, at the risk of adding another brake to an already sluggish economy?
But that’s where the picture brightens.
Central banks now know how to beat intolerably high inflation rates.
In the early 1980s, the central banks of the United States and Canada used sharp increases in interest rates to eradicate “runaway inflation” for good.
They are ready to start over, although the cure doesn’t have to be that hard this time.
The BOC has already started a gradual reduction in its purchases of government bonds on the open market, through which it has been helping to finance the government’s emergency stimulus measures since the start of the pandemic.
This puts downward pressure on price inflation. And around the same time next year, the BOC and its peers are expected to start raising their policy rates to further curb inflation.
These rate hikes, one of the most powerful tools to bring inflation down, will continue until inflation is within the BOC target range of 1-3%, ideally 2%.
The current BOC key rate of 0.25%, a record high, gives the bank enough leeway to reduce price inflation with interest rate hikes that do not dampen the economic recovery.
And inflation itself should help stall and eventually lower price inflation.
High prices discourage spending, of course. They also encourage business expansion, to take advantage of the higher prices. The result is an increase in production capacity, until supply catches up with demand. And it’s largely the supply shortages that have driven prices up.
It should be noted that the price inflation for goods, at nearly six percent, was about twice that of services, at about 2.7 percent. And services – healthcare, engineering and construction, professional services, retailing, etc. – represent around two thirds of economic activity.
And the prices of some important items have fallen this year, including mortgage interest and telecommunications services.
Price increases have been blatant, as noted, for goods, and in particular big-ticket items like cars, appliances, furniture, housing and home improvement products. Many of these goods are imported and are vulnerable to supply chain disruptions.
A balm for the sustained high prices is to postpone purchases of these products until next year or 2023, when prices will have returned to pre-pandemic levels. A nap of undeclared buyers would also relieve overtaxed global and local supply chains, putting even more downward pressure on prices.
As it turns out, 2% GDP growth is the norm for large, mature economies like Canada. This is simply not enough to quickly bring about a full economic recovery, which is only expected in the second half of next year.
The economy has recovered some three million jobs lost at the start of the pandemic. But job growth around the world is said to be more robust, alleviating labor shortages, with higher COVID-19 vaccination rates.
At the time of this writing, just over 75 percent of eligible Canadians are fully vaxxed. In the United States, where that number has been stuck at around 58 percent for months, an estimated one-third of the workforce is still unvaccinated.
“Vaccinate the world so we can see production ramp up everywhere,” proposed Kristalina Georgieva, managing director of the International Monetary Fund, as a cure for inflation in a climate change summit interview last week in Glasgow. .
The current plan to create a national child care system in Canada is one of the few fundamental government measures still taken to alleviate labor shortages by making it easier for parents to join the workforce.
Stagflation, while not a bogeyman, shouldn’t attract more than fleeting attention.
The issues that require more aggressive treatment are the same ones we faced before the pandemic. These include a global food supply threatened by the climate crisis, housing shortages and the growing imbalance between working-age Canadians and retirees.
And they understand the continued under-participation of women in the Canadian workforce; the gender pay gap; and an odd-job economy that forces Canadians to hold more than one job to make ends meet.
The agility that Canadians have developed to adapt to the first pandemic in a century should help us meet these challenges.
Be well. Be careful.