Inflation is too high and the economy’s been warped by years of cheap money. Now might be the time for some strong medicine
With energy prices soaring and consumers rushing back to restaurants and hotels, annual inflation spiked to 8.1 per cent, forcing central banks to get aggressive with their interest rate hike campaigns. In July, the Bank of Canada went so far as to surprise with a full percentage point rate increase, its largest since 1998. The question wasn’t whether Canada would have a recession, but, rather, just how painful it would be.
What no one seems to ask is: What if a recession is a good thing? What if a prolonged economic slump is exactly what Canada needs? The economy has also been warped by years of cheap debt – a byproduct of ultralow interest rates and the vast sums of money created to facilitate stimulus spending. “Fifteen years of that amount of liquidity, or free money, distorts the financial system,” says Mark Wiedman, of the global client business at BlackRock Inc., the world’s largest asset manager. “It also starts to distort the real economy.
The tech sector is already reckoning with a radical rethink. Perhaps the whole economy would benefit from a similar reset, so that financial assets stop growing faster than the real economy and GDP is less reliant on government spending. In other words, now might be the time for some very strong medicine.
Bank of Canada officials have repeatedly stressed that in order to truly tame inflation, something needs to give in the labour market. At the moment, it’s so tight that wages are rising by around 5 per cent on an annual basis. On the surface, that’s not disastrously high. But because Canada’s productivity growth is so weak, those higher compensation costs are tough to manage. The danger, then, is that consumers will foot the bill via higher prices.
An economic downturn could take the heat off the labour market, reduce the desperation for immigration and that could then ease demand for housing. In an economy, everything is connected. The paper noted that financial support for businesses during COVID-19 – a necessary thing to stave off economic collapse – may have prolonged the lives of companies that were on the brink of closing. Business insolvencies fell sharply during the acute phases of the health crisis.
That’s not to say a downturn would be all bad. She appreciates the frustrations and how a reset could take some pressure off. But recessions can be intractable. “The idea that you can calibrate it so that it is mild and short-lived,” she says, “that’s just way outside of our bounds.” At its core, the idea that a recession will cleanse things is tied to renowned Austrian-born economist Joseph Schumpeter’s theory of “creative destruction.” The free market might be messy, he argued in the 1940s, but it delivers growth in the long run. Job losses and corporate bankruptcies are all part of the process.
But it’s also easy to get lost in the debate. Mr. Cecchetti, the lead researcher on the study of past periods with high inflation, is very sympathetic to all these arguments, but he offers a counterpoint: “We’re never going to be able to avoid all pain for all people at all times,” he says.
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