July 24, 2021

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Postmortem: Inflation isn’t so bad, is it?

7 min read

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Financial Post columnist Kevin Carmichael, editor of the FP Economy newsletter, unpacks the week in economics.

Trading nation

Statistics Canada released its latest tally of imports and exports on June 8, recording a trade surplus of about $600 million in April, surprising Bay Street, which had been advised by the big banks’ economists to expect a shortfall.

There was a downbeat, though. The trade numbers were skewed by the shortage of semiconductor chips, which is wreaking havoc with the production of the machines of modern life. Canada isn’t a big maker of many of those machines, but we still assemble motor vehicles and make auto parts, and the modern automobile is essentially a computer on wheels. Imports of those things plunged 22 per cent and exports dropped 18 per cent, representing some of the biggest declines on record.

Still, trade remains a bright spot, all things considered. Commodity prices are off the charts, boosting the value of much of what Canada sells to the rest of the world. We didn’t get the same kick in the aftermath of the Great Recession, which is one of the reasons that recovery was so frustratingly slow. This time, exports have already topped pre-pandemic levels and they probably have more to give. Revenue from tourists and international students remains stuck at low levels because of travel restrictions. That economic motor should re-engage as soon as authorities are satisfied COVID-19 is under control. That moment might not be imminent, much to the frustration of Canada’s business lobbies; but it’s coming.


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Macklem’s dashboard, revisited

The Bank of Canada left interest rates unchanged on June 9, despite “robust” growth in the first quarter and expectations of a strong rebound from the third-wave of COVID-19 restrictions this spring. Policy-makers think there is little risk of a hot economy sparking inflation because a full recovery from the recession remains a long way off.

Governor Tiff Macklem and his deputies came to that conclusion by sifting through more data than is typically the case? We know Macklem is watching a “broad spectrum of indicators, including various measures of labour market conditions” in order to “gauge the evolution of slack” in the economy. But we don’t know which ones; the governor has opted to keep his dashboard to himself. So we’re forced to guess based on whatever clues the Bank of Canada leaves in its various public communications.

Last week, while explaining its new policy stance, the central bank observed that the “employment rate remains well below its pre-pandemic level, with low wage workers, youth and women continuing to bear the brunt of the job losses.”

Readers of FP Economy know the Bank of Canada is especially interested in the plight of lower wage workers and young people. (We updated those dials on Macklem’s dashboard last week.) Regular readers also will know that Macklem is keen on diversity, but we haven’t turned that interest into a chart, until now:


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The new dial on the dashboard is the employment rate. It’s a good one. It measures the percentage of the working age population that is employed, as opposed to the participation rate, which measures the percentage of the labour pool — the number of working age people who are working or say they are looking for — that is actually employed.

There were about 30.3 million people of working age in May, while the labour force consisted of about 20.2 million people, according to Statistics Canada. The employment rate is useful because it probably is less noisy at the moment. In normal times, it would be influenced by demographic changes over which the Bank of Canada has no control. But at the moment, it’s a decent indicator of how quickly the economy is climbing out of the hole left by the recession. That’s because the employment rate would be unaffected by idiosyncratic forces that could be skewing the participation rate, such as emergency jobless benefits and short-term skills mismatches between the unemployed and the jobs on offer.

The following chart shows the trajectory of the employment and participation rates since the start of the Great Recession back in 2008. Like the central bank said, there still is some ground to cover.


Price check

The Bank of Canada followed its policy update with an economic progress report on June 10, which came couched inside a speech by Deputy Governor Timothy Lane.


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Like everyone else these days, Lane said the Governing Council spent a lot of time talking about inflation as they deliberated on what to do next. The Bank of Canada’s leaders decided that recent price surges won’t last. Lane acknowledged that the Consumer Price Index (CPI) probably will run hotter over the next few months than he and his colleagues had anticipated in April, but he advised his audience to roll with it. Inflation is measured monthly by comparing current prices with the cost of goods and services a year earlier, and inflation was negative a year ago. That’s exaggerating current readings. Oil prices also are climbing, and that is putting upward pressure on the cost of gasoline, an important component of the CPI.

“Most of the run-up in inflation is simply arithmetic — base-year effects,” Lane said. “These base-year effects are, by definition, transitory — they will not persist beyond the next few months. What will persist until we see a complete recovery is the underlying slack in the economy. This slack will continue to put downward pressure on inflation as these base-year effects fade.”

By slack, Lane was referring to the weakness in the labour market that we highlighted above. It also shows up in the amount of productive capacity — factories, mines, and the like — that is sitting idle. Statistics Canada updated those figures on June 10. They suggest that many industries retain some idle capacity, but the headline number surpassed its pre-pandemic level during the first quarter. Construction was using 92.4 per cent of its capacity, the most since 1990. That heralds at least some inflationary pressure.


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Still, the inflation worries will persist. The U.S. CPI jumped five per cent in May from a year earlier, the largest gain since 2008. Lane acknowledged that he, Macklem and the rest of the Governing Council could be wrong about prices. He made a point of saying that the risks to the outlook they flagged in April “remain relevant,” including “the potential for more persistent cost pressures to push up inflation.”

It’s difficult to handicap the Bank of Canada’s inflation outlook. Anecdotal evidence suggests that inflation is everywhere. But while the U.S. numbers suggest that Canadian CPI is headed in the same direction, the correlation isn’t perfect:

It’s also worth emphasizing that policy-makers aren’t using arithmetic as an excuse to leave borrowing costs low. We compared the monthly rate of change in the CPI with its level two years earlier in case that made for a more reliable base at the moment. Based on that unorthodox measure, inflation is roughly were you’d expect it to be:



In-depth reporting on the innovation economy from The Logic, brought to you in partnership with the Financial Post.


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Kevin Carmichael

2021-06-14 05:00:33

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