Bank of Canada Deputy Governor Toni Gravelle was asked “the killer question,” if I may say so, after his presentation. And interestingly, it was sent to him by another central banker from the United States.
Posted at 6:30am
Toni Gravelle had just compared the inflationary context of today with that of the 1970s, which differed in several respects. He presented his views to the Association of Quebec Economists (ASDEQ) delegates gathered at the Palais des Congrès in Montreal.
The economy of the 1970s, Mr. Gravelle explained, was characterized by stagflation, “a period of simultaneous high inflation, high unemployment and very little or no growth. At the moment we are not seeing any stagnant aspects of stagflation, quite the opposite.”
According to this Bank of Canada board member, Canada’s economy is in full swing, which justifies the bank’s interest rate hike. Canada’s economy is projected to grow at a 5% annualized rate in the first half of 2022, according to the bank’s estimates, after posting 6% annualized quarterly growth over the last six months of 2021.
“The last time we saw this was during a 12-month period ending in mid-2000, 22 years ago. It was also the last time we raised our policy rate by 50 basis points,” he said.
In any case, forget the decade 1975-1985, he told the audience, with an inflation rate of 12%, an unemployment rate of 13% and a 5-year mortgage rate exceeding 20% in 19811.
And the “killer question,” as Guy A. Lepage would say? Be patient, she’s coming.
Toni Gravelle believes the Bank of Canada has the ability to orchestrate a soft landing of the economy, that is, slow it down without triggering a recession. This scenario, desired by all economists, would not be accompanied by a high unemployment rate due to the current labor shortage.
To do this, the bank’s interest rate hikes, combined with the weighted deflation of its balance sheet, must allow it to dampen demand enough to contain inflation. All of this would be possible despite the inflationary pressures that arise in particular from the global supply problems and the war.
The inflation rate, currently at 6%, will fall to around 2.5% in the second half of 2023 and return to the 2% target in 2024, the bank estimates. Hallelujah, we will be saved!
Less greedy workers?
Central to the scenario, Toni Gravelle believes that workers will be less greedy in their wage demands than they were in the 1970s, which will help bring down inflation.
“Wage dynamics have changed since the 1970s, when persistently high inflation played a larger role in wage negotiations,” he said.
As evidence, he explains, the average length of collective bargaining agreements in Canada doubled between 1980 and 2021, from 18-20 months to 42 months.
“Unionized workers feel the need to revise their collective agreement to keep up with price increases less often than they did in the 1970s or early 1980s,” Gravelle said.
The deputy governor read his written presentation verbatim, as is the bank’s tradition, to prevent markets from misinterpreting the message.
In short, the worrying inflation will eventually lose momentum, the 2% inflation target is on the horizon and the economy will bounce back.
The killer question in this context was asked by another central banker, Sylvain Leduc, a Quebecer who became senior vice president of the Federal Reserve Bank of San Francisco.
“You mentioned that the situation is different than in the 1970s, that the labor market has changed a lot. At the same time, workers have much more power today as the labor market is tight. Expected household inflation is also quite high in the short term. Do you see a risk that this could lead to much higher pay rises and could be an upside risk for inflation? »
Answer from Toni Gravelle: “We don’t see that in Canada like there. Wage increases have just returned to pre-pandemic levels. In addition, the distribution of unions is somewhat smaller than in the 1970s, which is not the case at the moment. Mr Gravelle also specified that this is one of the risks that explains why the bank wants to raise interest rates “so quickly” to what is considered neutral for the economy.
Of course, the economic situation is complex and delicate…
1. His presentation included a graph of the inflation rate and unemployment rate since the 1970’s, mortgage rates were not specifically mentioned.