It’s that time in our economic predicament when predicting a little bit of stagflation passes as optimism.
Canada’s former central banker, Stephen Poloz, is looking at climbing prices, volatile oil markets and lower growth prospects. And what he sees as a best-case scenario is stagflation — that oxymoron that tripped us up in the late 1970s, a simultaneous and toxic combination of slower growth, job loss and stubbornly high prices.
Only this time, it doesn’t have to be so brutal — as long as central banking authorities tread carefully and the world doesn’t throw any more extreme crises at us.
“The best we can manage, in this situation, is to endure a period of what people will call stagflation,” Poloz said in an interview.
With oil and gas prices so high, and the spillover effects trickling into everything else, consumers are feeling the bite in their purchasing power, he explains. That bite will eventually cut into our economic momentum, especially since the central bank is raising interest rates at the same time. So the economy will slow, leading to less hiring — even as consumer prices are still high.
That’s the definition of stagflation, Poloz points out, but he’s not implying we are poised to return to the 1970s, when oil supply shocks prompted the unemployment rate to soar in tandem with inflation.
“People think it’s ugly, which of course it can be,” Poloz said.
But that’s not his most likely scenario.
Poloz was head of the Bank of Canada from 2013 to 2020, starting his term during the Stephen Harper era, holding it down throughout Justin Trudeau’s first two terms in office, and handling monetary policy during the dark and confusing initial days of the pandemic.
He’s a pro and is not going to criticize his successor, Tiff Macklem, nor is he going to dive into the Conservative leadership race and discuss candidate Pierre Poilievre’s explosive comments about using bitcoin to control inflation and firing Macklem for being the stooge by bankrolling Trudeau’s spending.
Instead, he has his eye on how to engineer a soft landing.
The trick, of course, is for the Bank of Canada and other central banks to stifle inflation by raising interest rates and dampening growth — but not by so much that a recession and massive job loss are the result.
Poloz divides today’s inflation into two parts. On the one hand, there’s the inflation Canada can’t do anything about: the rising prices caused by oil and problems with supply around the world, especially because of Russia’s invasion of Ukraine and China’s COVID-19 restraints. On the other hand, there are domestic sources of inflation — from lots of government spending both during the pandemic and persisting today — that the Bank of Canada’s interest rates can actually influence.
Avoiding a recession, however, will require central bankers to constantly reassess the effects of higher rates as they rise. And it will require the public to maintain its faith in the ability of the central bank to get it right, Poloz said.
“They need to do that just enough (rate increases) so that people are convinced that inflation is going to stay under control, after the big hump is past us,” he said.
“That could mean a little bit of an uptick in unemployment, it could mean that. Right now, markets seem to be convinced that it (also) means having a recession. I don’t really agree, but I gotta admit that there could be one,” he explained.
“There is still a window to make our way through this without having one. Just have a slowdown in the economy. Probably a little bit of a rise in unemployment, just enough to contain that domestic inflation story while the outside inflation story rolls through the economy and people understand it as it happens.”
That’s not to say we should brace for widespread layoff notices. Right now, there are more jobs than workers these days, and a rise in unemployment is warranted in the name of returning to a balanced labour market.
Poloz is far from alone in contemplating a simultaneous slowdown in growth, a tempering of the job market and persistently high prices, but only some will go out on a limb and call it “stagflation” — mainly because it conjures up images of the 1970s.
Jimmy Jean, the chief economist at Desjardins, calls it “stagflation-lite.” Sluggish growth but still growing. Less hiring, but not massive layoffs. High energy prices mean Alberta and Saskatchewan will thrive even if the rest of the country stagnates.
However, Jean says there could come a point where things get worse — if companies try to pass on higher costs that come their way because of global supply problems or energy prices, and consumers can’t absorb higher prices.
In that scenario, “they must cut their overall costs to stay profitable. Unfortunately, one of the surefire ways to do it is to lay off workers. For that reason, my concern is that a potential stagflation would only really be a transition to a recession, rather than some kind of new ‘equilibrium,’” Jean says.
A few months ago, economists at the Conference Board of Canada modelled what stagflation would look like, but it was just a thought-experiment at the time. Then along came the Russian invasion of Ukraine, the renewed restrictions in China, and the realization that neither of those crises were going to go away fast, says forecaster Ted Mallett.
The stagflation scenario is now looking uncomfortably close, he says, even though it’s still not his base-case forecast.
“It’s turning into a grinding situation,” he says.
Whether you call it stagflation, stagflation-lite, or a grinding situation, it amounts to the same thing: walking a fine line between discomfort and disaster — and hoping the Bank of Canada doesn’t blow it.
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