Front Burner - Inflation has slowed. At what cost?

Episode Date: March 27, 2024

Canada's inflation numbers have once again come in lower than expected, and are nearing where our central bank wants them. But to get here, the Bank of Canada has kept interest rates high to slow the economy.So was it actually the Bank's rate hikes that brought inflation down? Is the sting of high rates worth the success so far? And how much further does inflation — and the economy — need to slow before the Bank drops rates? Armine Yalnizyan is an economist and the Atkinson Fellow On The Future Of Workers.

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 J.B. Poisson. For the last three years, since inflation took off to levels not seen in decades, your life has been getting more and more expensive. And in that time, Canada's central bank has repeatedly pulled the biggest,

meanest lever it's got to get inflation under control. The lever that raises interest rates. Bank of Canada's governor, Tiff Macklem, has been really unequivocal that this is the right path. We don't take our decisions lightly. And we don't want to put the economy and Canadians through more pain than we have to. And we are trying to find that balance. We don't want to put the economy and Canadians through more pain than we have to. And we are trying to find that balance. While now Canada's inflation numbers are back in the range our central bank is supposed to keep them in.

We just found out that for the second month in a row, the main number we used to measure inflation stayed within this magic target of 1 to 3 percent. Inflation was beaten down a little more last month with many price increases tamed and some prices actually falling. But I've got to point out, it's not like this lower inflation undoes all the previous price hikes. It just means most things are getting more expensive less quickly. And now at the same time that we're grappling with high prices, Canadians are dealing with the pain of high interest rates, which are designed to slow down the economy. So is this sting of interest rate hikes worth it to drop inflation? How much credit can the Bank of Canada actually take for getting inflation down? And why does it say it's not letting up?

Armin Ilnes-Yen is with me again. She's an economist and the Atkinson Fellow on the Future of Workers. Armin, thank you so much for coming on to the show. It was my pleasure. So back in the year, the Bank of Canada started raising interest rates. So 2022. I know you actually interviewed Bank Governor Tiff Macklin. And why did Macklin tell you this rate hike strategy was the right one to get inflation under control? The words that still ring in my ears is it's the plan. The plan always works.

That was literally what he said to me at the time. Why are we going so far so fast? It's true that since the 1990s, it has been literally official strategy starting in 1991. We were only months after New Zealand, which was the first central bank to decide that the way to wrestle inflation to the ground was to raise interest rates. And what that does is it cools demand. And if you cool demand, there's less pressure on prices. And so that's precisely what they've been doing. And there is certainly some room to say that it has been working. Without question,

it has slowed the economy from where it would have been had they not done anything. But I think what I want to get into with you more today is, you know, where it's worked, where it might not have worked, where the bank can take credit, where it can't. And before we do that, I wonder if we could talk about who has felt the pain of the high interest rates the most? Who has been the most affected here? Oh, listen, the people that have felt the most pain are the people that feel the most pain. Anytime anything bad happens, it's people with very few resources. And that is just a constant, whether you're talking about the pandemic, whether you're

talking about recession, it's always the people that lose their jobs, the people that didn't have a lot of money, the people that have very little wiggle room. And everybody knows that, including the central banks. But of course, they've only got the one tool. And that one tool is not designed to be distributionally sensitive. It is designed to cool an economy as a whole. And the people that pay the biggest price by buying less or losing their jobs are the people at the bottom of the income spectrum, by and large. Yeah. And tell me why they're hurt the most in this specific case. There's two ways you cool an economy. You make it too expensive for companies to keep borrowing to expand. So they may not make the hires that they would have otherwise done. You make it impossible

for some companies to continue paying what they were paying before. And so they have to reduce their operations by cutting staff. And that's on the business side. On the personal side is if you are raising the cost of the single biggest item in your household budget, which is housing, and you're affecting at least 40% of the market that has a mortgage, then there is less room for you to buy other things. It's just math. Unless your income is going up at the same pace as your mortgage payments or better, you're going to be changing what you're buying. And so it's that pulling back of discretionary spending or anything that's not got to do with shelter. And then that cascades into

the rental market. And we've been seeing that for a bunch of reasons that rents have been going up at a pace we haven't seen since the 80s. Are there people who have benefited from high interest rates, people or companies, institutions? Well, the number one institution that immediately got a windfall was the financial institutions, because they immediately pass through whatever the central bank's overnight rate are. They can lend money out at a higher rate. The second group of people would be anybody that had savings. Anybody that had savings without taking any risks can now get a much higher pay guaranteed investment certificate, if nothing else, that gives them more money.

The third group are people that take advantage of inflation. And those are companies that actually can set prices. Not all sectors have got players that can set prices. Not all sectors have got players that can set prices, but things like groceries, again, banks, telecom, all of these companies are able to set prices because there's so few large players. We heard from the telco chiefs about how these prices are falling dramatically, and there is further proof in this report that they are. Cell phone plans, for example, down by more than 26% in the past year. February was the first month that grocery prices rose more slowly than overall inflation since October of 2021. And there we have seen profit margins go up,

but in some cases also come back down again. There have been some true winners in this process, but there are far more losers than winners. And you mentioned before job cuts, but I wonder if you could explain something to me, Armeen, because I do keep seeing headlines saying that jobs are outperforming predictions. Like here's one from last month that says, Canada job gains double expectations. So why am I seeing stuff like that? Well, reason one is that we dealt with the pandemic reopening of the economy in all those sectors that were deemed non-essential.

Hotels and bars and restaurants, non-essential retail, personal services, all of those sectors, when we reopened the economy, there were more people with money to spend than there were people to do the job. And the way Canada dealt with that is by increasing the intake of newcomers. What we did was basically add people and stir at a time when the central bank was trying to reduce activity in the economy. So we added activity in the economy by adding people that not only work, but also consume. Now, there's been a lot of walking back some of those. Right, we're bringing in less people. Yeah, bringing in less international students and cutting back the permits given to temporary foreign workers.

Canada's immigration minister is vowing to slash the number of international student permits issued for the next two years, reducing them by a third to about 360,000 undergraduates next year. For the first time, Canada is capping the number of new temporary residents arriving here, including low-wage foreign workers. But we'll see if that combination of measures actually slows down the economy and does more of what the central bank was trying to do. In some sense, they were rowing against one another's interests. Let's talk a little bit about how and whether the plan to raise interest rates actually did what Tiff Macklem really wanted it to do, right? Now headline inflation is back into the 1% to 3% range, as I mentioned. The latest numbers from Statistics Canada found inflation cooled to 2.8%. That's the

slowest pace since June. It's also a drop. It's a combination of prices of all sorts of items, this percent combination. And which of those different prices can the bank actually take credit for reining in? It's very clear that the central bank is not just looking at the range one to three percent, but is actually looking at the middle of the range, two percent, as its target as an insurance policy. They want to be sure that they are getting closer to the mid of that range so that they don't have to do a lot of things. So that it can be kind of like the Seinfeld episode of monetary policy, where they do almost nothing, but they need to achieve that steady state of 2%. So are they in charge of doing this? Well, the biggest changes in the

inflation drivers are three things, gas, which went up and then came down and is now again going up, all because of Russia's invasion of Ukraine to begin with. So we're going to watch this gas price gauge go up and down for the foreseeable future. Central banks have nothing to do with gas prices. The second part is food prices. We are seeing both supply chains and production pick up again. But then we've got two new variables. One is theting their ships around the southern part of Africa, causing delays. They're also charging a war risk surcharge. And the other is climate change that is not only affecting drought conditions for growing crops and having livestock, but is also closing down the Panama Canal. So we are likely to see conditions for food and other kind of basic goods rise again

in the coming months. And again, central banks have nothing to do with how much it rains or what happens with war. The third factor that has driven inflation is housing. And there is absolutely the lever that the central bank is responsible for is how much does it cost for you to put a roof over your head if you are buying? So how much do you have to borrow at what rate? And there we are seeing rates of increase in mortgages that we have not seen since the 80s. And we're seeing rents rise at a rate that we have now only seen a couple of times in our history. And that story is far from over right now. So yeah, the central bank has something to do with inflation, but not the main characteristics.

The thing that really most affects is discretionary spending. And there you're seeing some kind of relief in things like going out to dinner or going to a show or- Buying a new pair of jeans. Or air travel was the really big one for a while. Yeah. And that's starting to, you know, cool off. But really, all of this pain is for discretionary. Yeah. So I think the obvious question is like you're describing to me two big factors that the bank has no control over and then one where they actually have made it worse. And so what was all of this for? Was it even necessary? Central banks were the only institution in the economy to tackle inflation historically. Back in the day, even before we had a central bank,

inflation rates went up and down. And we had lots of boom and bust. That was part of it. We also had federal governments actually directly attacking inflation by putting wage and price controls on or giving people money or building housing. There were different ways we managed inflation previously. But central banks have become this kind of knee-jerk reaction to inflation. And they have but one tool, and it is to cool demand. But this bout of inflation was about rising problems with supply. And it does nothing about supply. In fact, it makes supply, you know, Tip Macklin will say repeatedly, we're trying to bring

demand and supply into balance. But in the one thing that sucks up most of our money in our budgets, housing, that lack of supply is made worse by making it more expensive to build new supplies. So it's a problematic thing. It's not like they don't understand this, Jamie. They do, but they've got one tool to deal with inflation, and it is expected that they will beat inflation back. This is as much a credibility story as it is an economic story. I guess maybe another way to ask this question would be like, had they had done nothing, what do you think would have happened? Oh, had they done nothing, we would get inflation expectations taking over, which is we would just

expect prices to go galloping ahead. And that would allow all the bad actors in the economic system to just jack up prices because where are you going to go, right? Prices just keep going up. So there would be no underlying justification. And yet prices would be going up and we would all expect them to go up. So a huge part of a central bank's job is to have people expect price stability. And that's part of what they're doing. 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.

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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. Are there other options out there? What else could have happened in 2022, maybe in tandem with interest rate hikes or to replace them? Is there any other potential

solution here that isn't so broad and has such negative effects on the people who can least afford to have those negative consequences put upon them? We forget how much we did do fiscally at that time. We had the federal government in particular, put in extra GST credits that went to the poorest people, we have been creating cheaper childcare. And then they give us somewhere around 2020. We got this noise coming from Bay Street, basically, you got to get your house in order, you can't keep, you know, spending money, you have to pull back. And I think it spooked the finance minister because one of the big things about why we were able to do what we were able to do during the pandemic is we've got a triple A plus credit rating. That credit rating permits

us to borrow at bargain basement prices. And you don't want the credit rating to get worse, to go negative. So I think there was a real tightrope that the finance minister had to walk and started talking more about fiscal responsibility at a time exactly when inflation started burning holes in everybody's pockets. And suddenly the government that was there for you, had your back during the pandemic, was worrying about its bottom line. We need governments to step up to the plate. In Canada, that isn't just the federal government. It has to be all of

government rowing in the same direction to ease the pressures. And those pressures are largely taking the basics out of the economy, whether that's housing or childcare or healthcare. These things can't just be market driven, because the demand is so great for these things that the market will simply mark the prices up. If you want to do something about reducing the costs, and making sure people have the basics, there's lots you can do. And there's lots we have done. And we'll see what else, you know, is in store for us going forward. But it can't just be the central banks that are trying to make life better for us. Right.

And of course, just to point out the obvious here, there are people who obviously would disagree with the argument that you're making here that, you know, they would say that the government was spending way too much for too long. And that's why we were in the position that we were in. And they didn't pull back soon enough. There is that argument that governments have spent too much. That doesn't seem to have been the driver of these prices. When you take a look at what prices grew by what amount, it's not because people were suddenly eating more groceries that prices went up.

That argument has been there since the 80s. The reason you have inflation is because governments do big for its britches. The solution is to cut back government. That formula is a thought experiment, and it has failed since the 1980s. So whenever I hear it now, I mean, I've lived with that for most of my life as an economist. And it might have been true in the past, but it certainly is not true in a pandemic-driven inflation crisis. Before we go, I think, you know, one question that is on a lot of people's minds is when this might end, sort of the pain of these high interest rates. I know that the Bank of Canada, like I know they're thinking about rate cuts, but they want to see more first, including

wage growth slow down even more before they drop their rates. So I guess literally they want to see people get smaller raises, which is, I imagine, hard for people to hear since they probably need wage increases to catch up to how expensive inflation has made everything. You know, what are we going to see in the coming months? Like, when can people anticipate some kind of reprieve here? What might that reprieve look like? reprieve here? What might that reprieve look like? I should say that the way down on rates are going to look a lot different than the way up, which was very sudden, the most sudden in history. And it's true that low unemployment rates will continue. And that creates conditions where the bank is unlikely to see the softening of wage demands very quickly. Don't forget a lot of union deals are multi-year

deals, and they only come up this year. So we'll see what happens on that front. A handful of countries have already cut rates. So the Swiss central bank has cut rates. So has Brazil, Mexico, and Hungary, all because of dismal economic reasons, real contraction. Germany is in a recession. Britain is barely growing. And the European Central Bank signaled that it will cut rates in June. The US and the Bank of England, probably in June or July, it is widely expected they will cut rates three times. So even if the Bank of Canada did not see that wage softening, it would be very hard pressed not to cut somewhat, Canada did not see that wage softening, it would be very hard pressed not to cut somewhat because the more of a gap there is between the United States and Canada, the more you risk problems

between in the value of the dollar and capital flight. So I'm not sure what is going on. But you know, the market is factoring in about three more cuts in the second half of the year. Don't expect those rates to come down very far. They're talking about from 5% to 4.25%. We're unlikely to get to 3% anytime soon. Yeah, even if they start cutting rates, it's not going to be by a lot. Plus, just to remind people, all the reasons that we got to 2% in the 1990s, which was the huge glut of labor, huge unemployment rates of boomers, China coming on stream and becoming the factory of the world, and a super commodity cycle that really fueled everything here in Canada in the 1990s. All of these things

that were tailwinds back then that made it easy for the Bank of Canada to engineer 2% because there was so much downward pressure on prices have all become headwinds. So we've got labor shortages, China is in trouble, and we've got climate change. Plus, there's all these geopolitical frictions. There's a lot of things that will keep pushing prices up in a way we haven't seen in a couple of generations. So expect those interest rates to stay elevated. Well, I'm sure everyone will really love that ending note. Sorry. I mean, thank you very much. It's always a pleasure, even though

that was a little depressing at the end there. But I'm sorry, that's a little depressing at the end there. But thank you. I'm sorry. That's what I do. I'm Armenian. All right. That is all for today. I'm Jamie Poisson. Thanks so much for listening. Talk to you tomorrow.