By Kevin Lynch and Paul Deegan
Modern economies are driven by longer-term trends, shorter-term cycles and the occasional black swan shock, such as the financial crash of 2008-9 or the COVID-19 pandemic. Managing the resulting complexity is a constant challenge, requiring governments to have clear longer-term objectives but also the flexibility to respond to cycles and shocks. Unfortunately, Canadians hear very little these days from the major political parties about their policies for either the long-term problems of weak growth and stalling living standards or the short-term cyclical challenges of, for instance, today’s inflation .
When there are almost limitless demands for government help, convincing the public of the value of sometimes painful structural measures to boost long-term growth or fiscal restraint to tackle short-term inflation can be hard. But effective policy-making is about having the policy vision, the political courage and the willingness to explain “the why” to an often-sceptical public. Exceptions make the point: the Mulroney government’s embrace of free trade and the GST and the Chrétien government’s tackling of the deficit and backing of explicit inflation targets all bucked the conventional wisdom of the times and paid off for Canadians.
Today, however, political parties appear to be suffering an economic management deficit.
There is almost no serious debate about how to raise Canada’s anemic productivity, improve our lacklustre competitiveness, tackle our weak innovation performance and, most of all, raise our stagnating GDP per capita, the key determinant of our living standards, which the OECD says will rise more slowly than any other rich country’s over the next several decades.
Looking shorter-term, we are in the midst of an inflationary economic cycle driven by supply shocks, labour shortages and the aftermath of expansionary fiscal and monetary policies introduced to respond to the global pandemic. That this is the first inflation cycle in over three decades demonstrates the success of the inflation targeting that was introduced in the early 1990s. The downside of that success is that few of today’s leaders, whether in government, business, or finance, have had to deal with rapidly rising inflation and its consequences — and it shows.
After a slow start, the Bank of Canada has aggressively raised interest rates to dampen demand and re-anchor inflation expectations around its official two per cent target. Absent from this policy cycle, however, was the fiscal restraint to help rein in surging demand before higher expectations become embedded in wage- and price-setting. Government policy has actually been pro cyclical. With the economy growing and unemployment at 50-year lows, Ottawa increased federal spending, increased the deficit, increased the debt, and expanded the federal workforce.
What ever happened to counter-cyclical fiscal policy? At the end of 2022, despite widespread labour shortages and inflation running five per cent above target, Ottawa continued to stimulate the economy, refusing to curtail discretionary spending, shift capital outlays to beyond the cycle, freeze the size of the public service or do anything else to pull back on demand and help the Bank of Canada get inflation back under control.
Compounding its procyclical fiscal policy, the government has made the inflation battle harder by increasing immigration flows at a time of severe housing shortages and sharply rising rents and home prices. Population growth in excess of 2.5 per cent, almost totally driven by immigration, is boosting demand pressures in the economy, especially in the residential sector, at exactly the wrong stage of the cycle. Why not scale back immigration in the short term and ramp it back up when the economy comes out of this inflationary economic cycle? Immigration is crucial to the long-term goals of reducing the population’s average age and attracting much-needed skills and talent, but focusing on the long term shouldn’t mean losing sight of the serious difficulties it creates in the short term.
As to housing, which has been a major driver of this inflation cycle: what the economy needs is more supply, not more demand. And yet several recent policy measures aimed at improving affordability for targeted groups have actually raised net housing demand. All three levels of government need to do their bit in the inflation fight by encouraging housing supply.
Cycles are part of any economy’s evolution. Counter-cyclical policy needs to be a standard part of the policy toolkit of governments today — as it once was.
Source: Financial Post
