Canada’s economy added a stunning 150,000 jobs last month. It’s the second straight month that jobs numbers blew well past expectations. And it’s yet one more data point that challenges the narrative that Canada needs to shed jobs to bring inflation under control.
“We’re seeing a key test of our theories of how labour market tightness translates to wages and from wages to prices,” said Brendon Bernard, chief economist at the job search site Indeed.
Economic theory tells us that unemployment and inflation are inextricably linked. As unemployment falls and more people work, inflation increases. And as unemployment increases, inflation drops.
But that’s not what’s happening here. Inflation peaked in June at 8.1 per cent. It has decelerated considerably since then. In December, it had fallen to 6.3 per cent and is expected to fall all the way to 5.6 per cent when we get January’s numbers later this month.
“Theories are always being tested,” said Bernard. “But I think in really unique times like this, that’s even more the case. Partially because the pressure is really on. There are major policy implications of how things evolve in the next six months or a year.”
The policy implications of this are enormous.
‘Must make them at least a tad nervous’
Canadians are already squeezed — pinched between rising prices and increased borrowing costs. The Bank of Canada raised rates by another 25 basis points earlier this year. But it also signaled it was ready to pause rate hikes going forward.
“If economic developments evolve broadly in line with the [bank’s] outlook, Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases,” wrote the central bank in its last decision.
Canada has now added 326,000 jobs since the beginning of September. That was certainly not in line with the Bank of Canada’s outlook.
“For the Bank of Canada, the strong [jobs] report must make them at least a tad nervous about their freshly-minted pause — we said the bar for any move would be very high, but the employment gain is pretty towering indeed,” wrote BMO Capital Markets chief economist Douglas Porter in a research note.
But economists like Jim Stanford say continuing to hike rates now is unnecessary and needlessly painful.
He’s been saying for months that inflation was driven by global factors like the price of oil and shipping. He says it’s been exacerbated at home by corporations hiking prices more than their input costs.
“We’ve been barking up the wrong tree on both the cause of inflation and how to fix it,” said Stanford, an economist and director at the Centre for Future Work.
The Canadian economy added 100,000 jobs in December, exceeding expectations and signaling to the Bank of Canada that another interest rate hike might be necessary.
He says most conventional thinking around inflation is that prices are driven up by too much spending. So, the orthodox response is to cool the labour market and put people out of work.
The problem, according to Stanford, is that in this particular environment, inflation is not following the textbook model.
“I think the assumption that you can’t have low unemployment without blowing the roof off inflation is being proved wrong day by day,” Stanford told CBC News.
‘No easy way to restore price stability’
The orthodoxy around the relationship between jobs and inflation isn’t the only theory being challenged right now.
Conservative Leader Pierre Poilievre has attacked the credibility of the Bank of Canada, saying it didn’t recognize the perils of inflation as it ramped up last year and has been too focused on supporting markets instead of regular Canadians.
Bank of Canada governor Tiff Macklem gave a speech this week entitled “How monetary policy works.” In that address, he tried to make a case for how the bank has seen the last year or so unfold.
“We know that the monetary policy tightening we’ve undertaken is hard on many Canadians. Unfortunately, there is no easy way to restore price stability. Monetary policy doesn’t work as quickly or painlessly as everyone would like, but it works,” said Macklem.
Communication and transparency are key to making sure Canadians understand and trust what the bank is doing. After a critical report from the International Monetary Fund last year, the Bank of Canada agreed to release more information around how it makes its decisions.
This week the bank unveiled its first ever Summary of Deliberations. It didn’t offer any surprises, but it is a clear attempt by the central bank to become more transparent.
A weird time for the economy
All this speaks to a uniquely weird time in both the Canadian and the global economies.
An unprecedented pandemic crashed into the economy just three years ago. Overnight it shocked markets and supply chains. It fundamentally changed how we live and work.
Now as life slowly creaks back to normal, economists say it can’t be much of a surprise that the old models and economic theories aren’t exactly spot-on.
The jobs report is just one data point and the Bank of Canada has more to consider before its next interest rate decision on March 8. Chief among those will be the next inflation report on Feb 21.
On the upside, there are an awful lot of positive forces at play right now. Inflation is decelerating, the economy has slowed, but hasn’t slipped into a recession, and experts say that red-hot jobs market should act as something of a buffer against a pretty lousy forecast for the first half of this year.
