A pandemic, a war, rising inflation and interest rate hikes. All the ingredients that cause recessions are in place right now. Despite a booming economy, Canada is not immune to a sharp slowdown in growth.
Posted yesterday at 5:00am
Most economists agree that the risks of a recession are increasing. Ever since the Bank of Canada made clear its intention to raise interest rates quickly to calm inflation, the odds of a recession have increased, says Steve Ambler, associate professor at Montreal’s School of Management University of Quebec and holder of the David Dodge Chair in Monetary Politics.
“Current interest rates, which are still very low after two hikes this year, need to rise much more to combat inflation, which exceeds the Bank of Canada’s target of 4.6%,” he said.
How high can interest rates go before the economy falters? The Bank of Canada has in mind what it calls a neutral interest rate that will allow the economy to grow without causing inflation. That ideal (and theoretical) rate is around 2.5%, according to monetary authorities.
However, with inflation currently above 6%, it is almost certain that rates will need to be kept above this neutral rate for some time to come, Steve Ambler believes.
The economy begins to suffer when interest rates exceed what is considered the ideal interest rate. The Bank of Canada governor believes the Canadian economy can handle higher interest rates. The central bank forecasts economic growth of 4.2% this year and 3.2% in 2023. Even if these forecasts turn out to be overly optimistic, there is still some room before they turn negative, argued Tiff Macklem last week again before the elected representatives of the federal government.
A recession if necessary
The recession, if there is one, won’t happen this year, say several economists, including Jean-François Perreault, Scotiabank’s chief economist. The Bank of Canada has taken its foot off the accelerator but hasn’t hit the brakes yet, he believes. Rate hikes will slow the machine, but it still has enough fuel to keep going for a few more months, he said.
The situation is different in Europe, where the war in Ukraine and rising energy prices have caused an economic shock.
Much of the current concern about the likelihood of a recession stems from what is happening in Ukraine. It is likely that several countries in Europe will find themselves in recession.
Jean-François Perreault, chief economist at Scotiabank
If that happens, Canada won’t suffer too much because it’s a producer of commodities that will find buyers elsewhere when the European economy freezes. On the other hand, if the American economy suffers, the northern neighbor will not get away.
On this side of the Atlantic, the main risk is inflation, says Jean-François Perreault, and how central banks will tackle it.
Rate hikes won’t lower oil and other commodity prices, but will calm consumption and housing frenzy. The Scotia economist points out that the Bank of Canada has repeatedly said it is committed to bringing inflation back to its 2% target, suggesting it wants to reach that target at all costs, itself at the expense of a recession.
Excessively high interest rates inevitably lead to a recession. At least that is what recent history teaches us.
“It’s an avoidable scenario, however, believes Jimmy Jean, chief economist at Desjardins, but some things have to go well. »
First, central banks in both Canada and the United States need to hike rates more aggressively to stop stimulating the economy. “The longer we wait, the more we expose ourselves to the risk of having to keep raising interest rates for longer. Rate hikes can take 18 to 24 months to impact the real economy, he said.
If inflation shows signs of slowing or stabilizing, the chances of a soft landing increase, says Jimmy Jean.
After all, there must be no further shocks hitting the world economy.
Will the current combination of pandemic, war and inflation lead straight to recession? Everything depends on the results achieved by the Bank of Canada and the United States Federal Reserve in the fight against inflation that has just begun.
Three scenarios are possible, summarizes Miville Tremblay, fellow of the CD Howe Institute and CIRANO, who is also a former Bank of Canada.
“The ideal is a soft landing, where demand settles down a bit and inflation approaches 2% in a year or two,” he says. The second is stagflation, where growth stalls sharply but inflation persists due to shortages and supply shocks. The third is that of a recession, in which the rise in interest rates breaks the reins of growth. »
It is very difficult to assign probabilities to these scenarios due to the unusual combination of factors currently affecting the global economy. “We must wish each other good luck! ‘ he concludes.
The ABC of the Recession
A recession is a decline in economic activity, as measured by gross domestic product (GDP), for at least two consecutive quarters. It is characterized by a significant increase in the unemployment rate and a significant fall in consumption and investment, which can last a few months or several years.
The damage caused by a recession is measured in lost production, but also in the human tragedies caused by job losses, bankruptcies and falling living standards.
A downturn in the economy is rarely caused by a single factor or event. There are usually several causes such as over-indebtedness, speculative bubbles or a pandemic-related shock that ultimately fuel inflation.
Recent recessions in Canada
The pandemic caused a sudden and short-lived recession that was very different from other episodes of Canada’s economic decline. Before the big slump of 2020, the last “normal” recession was in 2008.
The weak Canadian dollar and rising inflation prompted the Bank of Canada to raise interest rates and keep them high, causing Canada’s longest recession since the 1930s.
Duration: 6 semesters
Policy rate: 21%
Unemployment rate: 12.8%
GDP decline: 4.9%
Again, it was the fight against inflation by raising interest rates that plunged Canada into a recession in 1990. Unlike the others, this recession was not caused by a slowdown in the American economy and was considered the first recession made in Canada.
Duration: 5 semesters
Policy rate: 14.5%
Unemployment rate: 12%
GDP decline: 3.4%
The financial crisis in the United States and the collapse of the American real estate sector shook the international financial system and plunged the Canadian economy into recession.
Duration: 3 semesters
Policy rate: 4.5%
Unemployment rate: 9%
GDP decline: 3.6%