Front Burner - Has the Bank of Canada gone too far?

Episode Date: July 13, 2023

There’s a growing chorus of critics of the central bank’s decision to increase interest rates, as things like food and housing are keeping inflation up, and seem largely unaffected by higher rates. This comes as the Bank of Canada increased its key interest rate on Wednesday. It’s the 10th time the central bank has hiked the rate since March, 2022 — bringing it to five per cent. The move is all part of an effort to rein in high inflation, but that has come down significantly since its peak last year. Armine Yalnizyan, economist and the Atkinson Fellow On The Future Of Workers, explains on today’s episode. For transcripts of this series, please visit: https://www.cbc.ca/radio/frontburner/transcripts

In the Dragon's Den, a simple pitch can lead to a life-changing connection. Watch new episodes of Dragon's Den free on CBC Gem. Brought to you in part by National Angel Capital Organization, empowering Canada's entrepreneurs through angel investment and industry connections. This is a CBC Podcast. Hi, I'm Tamara Kandaker. So yesterday, the Bank of Canada announced another increase to its key interest rate. As expected, the Bank of Canada has raised its key benchmark interest rate by 25 basis points to 5%. This is the 10th time the central bank has increased the rate since March of last year. And at 5%, we've now got the highest rate in 20 years.

The bank says the goal is to bring down inflation, but its leadership actually admitted that rate hikes are going to hit some people hard. We know that the most vulnerable Canadians are the ones that are hurt most, both by inflation and by higher interest rates. The prime minister said the move was an unwelcome development. How concerned are you that Canadians are going to start defaulting on mortgages and other debts? Look, this is not the news that any Canadian

wanted to receive this morning. There's also a growing chorus of critics who say that these rate hikes need to stop, that they can't fix the real issues behind why life has become so unaffordable. Others go further and say that interest rate hikes might actually be making inflation worse. So today, we're going to do a bit of a reality check on rate hikes with Armin Jelnezian. She's an economist and the Atkinson Fellow on the future of workers. Hi, Armin. Nice to have you back on FrontBurner. It's terrific to be here, Tamara.

So I want to start by getting your help to paint a picture of what Canada's economic situation looks like right now. So inflation has come down since last year, but it's still at about three and a half percent. What does that mean for Canadians? Well, nobody wants inflation, right? That means that what you're paying at the grocery store, what you're paying for rent, what you're paying for everything is more than it was last year. But three and a half percent is a whole lot better than where we were at last summer. So inflation is getting very close to where it was before the pandemic. And that's really good news that inflation is coming down

quite strongly. And so just to be clear about what that means, the price of consumer goods isn't coming down. It's still rising, but at a slower pace than before, right? But still not as slow as the Bank of Canada would like. That's right. When the pace of inflation drops from last summer to this summer, it doesn't mean that prices are falling. It's continuing to rise at a rate that more resembles the pre-pandemic period than what we certainly saw for the last year, but it's still quite a bit higher than we would like it to be to be able to just forget about price increases. Okay, so that's the situation with inflation. And in terms of interest rates, in the last year and a half, they've gone from almost zero to well now 5%.

Where have the increase in interest rates been felt by normal people? The first sector of the economy to respond to higher interest rates is housing. It's the most interest rate sensitive and you're seeing it in mortgage rate increases, but you're also seeing that spill over into the rental market too. increases, but you're also seeing that spill over into the rental market too. But what happens next, the next shoe to fall is that people start losing hours of work as borrowing costs go higher, businesses can't expand as much. So not as many people get hired. We're seeing that with the summer hire process. And people are finding that they're paying more for leasing or for servicing existing debt, and businesses are trimming hours. So whether you're losing a job, you can't get a job,

or you are losing hours of work, more people are losing more purchasing power, not just to prices going up, but because demand is cooling. And that's by design. That's the point of raising rates so quickly. Right. I just want to zoom in on mortgages for a second, because there are a lot of people in my life who are really struggling with mortgage payments because of these interest rate hikes. And I'm sure a lot of people who are listening would have also felt the impact of this. And about a month ago, there was a story about the IMF, the International Monetary Fund, warning that out of a group of 38 countries, Canada was among those at highest risk of

people defaulting on their mortgages. And I was wondering, are we starting to see that happen? Well, for sure, you're going to start seeing more defaults than we've had historically, because as elevated as our indebtedness has been, Canada's got one of the highest rates of household indebtedness in the world. But it's because of our housing costs, they're so high, we have to borrow more money to be able to buy a house now than at any point in history. So there are all sorts of techniques we can use to minimize defaults, though the banks are prepared, and we are starting to see some of the beginnings of those type of defaults. The other side of this story is, the economy has been incredibly resilient. Yes,

young people are having trouble finding summer jobs. But prime age workers 25 to 54 years of age, who are the people that are most likely to have mortgages, their rate of employment has gone up, and incomes are going up. So people are more insulated than we thought they would be at this stage. It's not as bad as we thought it would be. But just going back to debt for a second, I know food bank use is way up and people will cut costs kind of everywhere else in their life before missing a mortgage payment. So do we have a sense of whether people are defaulting on other types of debt or falling behind on bills? growing share of people, whether they own mortgages or are renting, or even if they already own their house without a mortgage, a growing share of people are spending more than the income

that is coming in. Things are getting worse for a handful of people. And it's always the people that are the hardest hit, like about 25% of households are either food or housing insecure. So that's a large number of human beings. And we are just tightening the screws again, which means there will be more people added to their ranks. So in this current economic climate, basically since the pandemic measures started to wind down and interest rates and inflation have been high. Who have been the biggest losers? Currently, the people that are hurting the most are low-wage workers and people who are renting. Those are the people that are being dinged the most. They're most likely to lose their jobs and they're most likely to lose their

housing and not be able to find anything cheaper. So this is a very problematic period for them and for anybody that was already using a food bank. Food banks are operating at maximum demand with minimum revenues. So yeah, lots of demand for services and not much supply at the lowest end of the spectrum. It's being called the perfect storm, high inflation, low incomes and outdated government policies. According to the report by Foodbanks Canada, one in four food banks is now seeing a 50% increase in demand and around 500,000 clients, about a third are children. And then if you could break it down, who has been

doing well in this climate? Yeah, contrast that with people who have a little bit of extra cash can look at a 6% GIC and, you know, to quote Dire Straits, it's money for nothing and your risk for free. 6% GIC for doing absolutely nothing with your spare savings is pretty sweet compared to what it was like a few years ago. Financial firms are laughing all the way to the bank. Oh, wait, they are the banks. Energy companies have been doing extremely well because of Russia's invasion of Ukraine.

That has nothing to do with interest rates, butbeys and Metro, brought in $3.6 billion in profits last year. That's up 50 percent over four years. And that's as food prices have been climbing. And the bureau said that, quote, Canada needs solutions to bring grocery prices in check. More competition is a key part of that answer. That may be part of the answer, according to the Bureau. But doesn't it raise a tougher question about how to increase competition in the retail grocery industry? My friend, it raises the question of how we increase competition in any part of an economy that is highly reliant on a small number of players. In almost every sector, you can think of banking, telecom, mining, retail, you know, the list goes on and on. We are a very small consumer market compared to other big economies. And we have tended to see growing corporate concentration in all of those markets in the last couple of decades. So this is really the major quest is,

how do you increase competition to be able to bring prices down? You know, I've seen the term greedflation come up a lot in the writing around this, and I've seen it come up in some unexpected places. So even the former vice chair of the U.S. Federal Reserve, he didn't use that word, but he said it was companies essentially price gouging that was a main driver of inflation. Yeah, we're seeing this new narrative come up everywhere, including it's not so much what is being said, but who's saying it. A few days ago, we saw the Bank of England governor mentioned that retailers were overcharging customers. We've got to get, and we will get, inflation back to its target. To do that, we cannot continue to

have the current level of wage increases, and we can't have companies seeking to rebuild profit margins, which means prices continue to go up at their current rates. And yet, you know, the beatings will continue until morale improves. We are going to raise rates anyway. Not that raising rates does anything about the way companies set prices. So we've got a bit of a disconnect here between what the medicine is for higher prices and what it is that's causing higher prices. We don't know the degree to which price setting by large players in markets is the reason prices are going up, but more people are becoming aware that that's part of the mix. So like we said, inflation is coming down, which means consumer goods aren't getting more expensive as quickly.

But there are still two major parts of everyone's budget that are going up fast, food and housing. So let's talk about those, starting with housing. Why haven't the steepest rate hikes in Canadian history done anything there? Well, in fact, in the first six months of 2023, housing prices did go down, but they're now starting to pick up again. And part of that resilience is the fact that we have poured a million people into the system in the last year, and they need a place to go, and there's just not enough supply. So that's jacking up the price of rental housing as well as home ownership. That's the short answer. Okay, so then we have food prices. Why hasn't raising interest rates brought food inflation

down? There's nothing about food prices that are interest rate sensitive, other than you are slowing demand, you are actually making it too hard for people to buy more. Basically nothing that central bank policies can do about food costs. This is something that has got to do with global commodity prices of fertilizer, of grains like wheat and barley, and of seed oils. And those are the prices that are the highest compared to this time last year still on the grocery shelves. Anything to do with baked goods, anything to do with cooking oils, those are really high. Pasta products, my gosh, eye-wateringly higher than this time last year. And these are all the staples that food banks rely on

too. So this is really problematic that the most basic foods are still quite a bit higher now than they were this time last year. We are still dealing with supply shortages on global markets. So now there's a chorus of critics that's emerged when it comes to rate hikes at this point. And it's coming from all sorts of directions. In the U.S., there was a group of lawmakers. Here in Canada, the Canadian Union of Public Employees, CUPE, has been saying this since last year. Even a senior economist at CIBC was urging the Bank of Canada not to go through with this increase. He called it, at best, unnecessary and, at worst, a mistake. And I just want to go through some of the criticisms with you. Big picture, why do people like this think the central bank is pushing it too far?

Well, there was a great headline in Bloomberg that said the Fed is fighting a battle. It has already won. And the problem is that inflation has been coming down. It's been coming down from around 8% to, as you pointed out earlier, 3.5%. That's a pretty good drop in the course of the year. And we know that when central banks raise rates, it takes between a year and a half to two years for the full impact of those hikes to take hold. So we know we haven't seen the end yet. And people are really making the point that getting from three and a half to two percent requires so much more pain that it's not worth it. It's that last yard that is the most painful and really seems unnecessary.

It's almost like serving at the altar of a number, two percent. You know, why would we be doing that when it throws so many people out of work? Watch new episodes of Dragon's Den free on CBC Gem. Brought to you in part by National Angel Capital Organization. Empowering Canada's entrepreneurs through angel investment and industry connections. Hi, it's Ramit Sethi here. You may have seen my money show on Netflix. I've been talking about money for 20 years. I've talked to millions of people and I have some startling numbers to share with you. Did you know that of the people I speak to, 50% of them do not

know their own household income? That's not a typo, 50%. That's because money is confusing. In my new book and podcast, Money for Couples, I help you and your partner create a financial vision together. To listen to this podcast, just search for Money for Couples. vision together. To listen to this podcast, just search for Money for Cops. So mortgage costs went up 30% in the past year, the largest single contributor to the inflation rate going up. If the cost of mortgages were stripped out, the official inflation rate would have been 2.5%, which is well within the range of the 1 to 3 that the bank is targeting. So are these moves actually making inflation worse? It's a great question. And it was asked repeatedly of the Bank of Canada governor and deputy governor at their latest press release. Pete Evans from CBC,

please. Yes, Pete, go ahead. If you strip out mortgage costs, inflation is actually within the target range. So can you explain to Canadians who aren't economists how making those mortgage costs even higher is going to help bring down the cost of living? Do you worry at all about losing credibility with them with the seeming disconnect between making things more expensive so you can make things less expensive? And they had a really nice counter to that, which is that if you take gasoline prices, which are the ones that came down the most rapidly, one of the major reasons why inflation fell from 8% to 3.5% roughly, then you would have higher than average inflation. You'd have it at about 4.5%. So,

it depends on what you include or what you rule out. What they are saying is it's the entire basket of goods and services that consumers buy that you have to measure. It's the broad range of things that we buy that we need to keep in check and in mind. So if the central bank is going to have a hard time bringing down food and housing costs. And, you know, given all this criticism, why are they insisting on raising interest rates? Because since the 1990s, the single policy for wrestling inflation to the ground has been slowing demand. And what does that mean? It's a technical term to say we need more people that are unemployed, fewer people that can afford to buy stuff. It literally means we must engineer more pain so that there is less price pressure in the system. It's kind of a brutal way of thinking about what monetary policy is. But at this point, that's exactly what it is.

Okay, so this is where I ask you about other ways this country can try to address inflation beyond that Bank of Canada lever of simply raising interest rates. So let's start with food. Are there things you would like to see the government do to ease food costs? well you know historically we had marketing boards uh which did uh limit the pace of price increase as well as not drive producers under uh we have gotten rid of one of them the wheat marketing board but we do have egg and dairy uh marketing boards still on the books and that does moderate price increases we've actually seen it live and in technicolor as a social experiment between Canada and the US during this terrible year of inflation where our prices for these goods went up much more slowly than in the US. But the other side of it is that neither governments nor

central banks can do much about food prices. One of the things we could be doing is, did you know that in Canada, we are the only country in the advanced economic world to not have a school food program that is national? We have different school food programs from province to province and territory, but not one national approach to make sure that no kid goes hungry. And that's something that is on the books, it's in the mandate letter of both the agriculture minister and the minister responsible for children at the federal level. And we've been expecting to see something happen since food prices took off, and so far, crickets. So that's definitely something that could be done immediately, that has been promised to be done.

Right. Okay. And what about housing? What's the move there? Are there regulatory or investment programs that you think would lead to a real improvement in housing affordability in Canada? Oh, my God. This is the area where there is so much we could be doing. And it's kind of imponderable that we haven't been doing any of it, given that we keep inviting more people into the country. So the first thing that should have been done, and it should have been done last fall in the fall economic statement, was that the federal government would backfill the difference in costs for actually constructing affordable, purpose-built rental housing that was already permitted and on the books. So much of that construction has stalled out at a time when there isn't anything new, affordable being added to the market. Affordability is being pulled out of the market. So we need to at least stop stalling what was going to be built. The federal government absolutely could be stepping up government-funded builds of affordable housing because the market will never do it. It never makes any mathematical

sense for the market to provide what's called affordable housing that is truly affordable. In other words, you know, not eating up half or more of your income to be able to have a roof over your head. So, those are two things that can be done. We have rent controls. At the city level, we could be changing zoning bylaws to densify the housing footprint we have, or actually changing what might have been an industrial location or an office building, and maybe having co-developing with housing. There's so much we could be doing to improve the footprint we already have and put what we've got to better use, as well as making it cheaper. But we're

doing nothing. It's like that Simpsons episode where the character says, you know, we've tried So I want to end by asking you about this thing that the Bank of Canada Governor Tiff Macklem said during his press conference yesterday. We need to see demand grow slow, wage pressures moderate, and corporate pricing behavior normalize. And that part at the end helped me decode that. We need to see corporate pricing behavior normalize. And that part at the end, help me decode that. We need to see corporate pricing behavior normalize. He's basically saying companies need to stop adding inflationary pressure with how much they're choosing to charge, right? But if that's not something the central

bank can do anything about, what can be done about these huge companies raking in profits that are contributing to the problem here? It's a great question. And it was also a bit of an eyebrow raiser for me to see those terms of corporate pricing behavior. There's nothing that the Bank of Canada can do directly about corporate pricing behavior. And in fact, we don't know what corporate pricing behavior is. We don't have an insight as to how companies raise prices. But we do know when there are fewer players in a market, they have more market share, and they're more able to set prices. And what the bank is doing by raising rates means that

there are going to be fewer players in any ecosystem, the smaller players will get ticked off. They can no longer afford to keep borrowing, or they can't afford to pay off the financial requirements they've got. So they drop out. That's where the bankruptcies happen. And that means that the bigger players take over even more market share. keeping an eye out for how pricing behavior is changing, but their very behavior at the bank by raising rates will mean fewer competitors, which will mean more ability to set prices in a lot of markets. And that's a huge concern. And that's where governments can come in. You can tax excessive profits, but you need a very good definition of what excess looks like. And when you actually change market structure to have fewer and fewer players, it doesn't look like excess anymore. That's what becomes normal. So I don't actually know how you regulate pricing behavior if all of your policies are leading to more corporate concentration. And that has been the long-term trend in the wake of the 2008-9 global financial crisis. So this is a very big story and one that is the deepest challenge for governments

everywhere. When companies are operating on your territory that are even bigger than your own economy, how do you regulate them? Armin, thank you so much for helping us wrap our heads around this. I appreciate it. Tamara, it's been a real pleasure. All right, that's all for today. Thank you so much for listening. I'm Tamara Kendacker, and I will talk to you tomorrow.