This post is the first of a two part analysis documenting the failings of current economic thinking as evidenced by the policies of central banks like the Bank of Canada.
One can compare the Bank of Canada’s tackling of inflation through repeated aggressive rises in interest rates (six times already this year) to what bloodletting would be to 21st century medicine. Such an approach reflects a profound misconception of the workings of monetary policy with its dismal track record in causing past economic recessions, marked by spikes in unemployment and its incalculable harm to both people’s living standards and business enterprises. Why repeat these mistakes again? The simple though painful reason is that when you see a sledgehammer as the only available tool, everything looks like a nail.
Inflation is the measure of the increases in average consumer prices for a basket of goods and services, the consumer price index (CPI). After nearly two decades of inflation hovering around 2%, CPI began to surge in 2021 and even more so in the first half of 2022, recording a high of 8.6% in June 2022. This was the largest increase in a year since 1981. It is still lower than the OECD average of 10.3% but raised alarm bells in Canada and elsewhere.
By September it had already fallen to 6.9%, a not unremarkable decline of about 20%. Yet the Bank of Canada pressed forward with its rate hike (the prime rate currently set at 5.95%) with the promise of more increases to follow.
The question is whether the Bank of Canada’s monetary approach constitutes an unwarranted attack on jobs and prosperity – an unnecessary and misdirected exercise of its mandate. Less than a year ago, the Bank’s mandate was reviewed with monetary policy to be managed in ways that do not exacerbate job losses or push the economy into recession. Bringing down inflation by bleeding the life out of the economy, losing tens of thousands of jobs, and eroding confidence in the dollar violates its own mandate and is a cure worse than the disease.
Authoritative, credible monetary and economic sources have presented clear and compelling evidence that discredits this reckless and foolhardy policy approach. Yet, central bankers and governments in many of the world`s most advanced economies remain fixated on this approach and continue to walk in lock step toward the precipice. They are undeterred by the more than likely, unfortunate consequence of a recession and the costs to the economy in job losses and business prospects.
In the meantime, Canadian households will bear the brunt of this approach. They are struggling with the skyrocketing costs of living driven by the costly prices for food, housing, and gas. For many, paycheques fail to cover these rising costs, even compelling some to choose between paying their rent, utilities, transportation or buying groceries.
Prevailing Causes of Inflation
False Narrative #1: The Demand-Side Wage Spiral
Canadian workers certainly did not cause the inflationary crisis in the living costs they are facing now. In fact, many have lost more than 10 per cent in real purchasing power in recent years. Conservative economists raise concerns that workers may seek wage increases to catch up with this lost income. They argue that if employers agreed to workers demands, and then increased prices to make up for their higher labour costs, this would lead inevitably to the wage/price spiral, they fear and resent so much.
This fear is quite unwarranted. Wages have persistently lagged behind rising living costs for decades. Besides, with future economic growth in Canada expected to be an anemic 1.5%, when a healthy rate would sit between 2.5 to 3.5%, it seems highly unlikely that wage earners will see their take home pay catch up with current inflation rates any time soon.
False Narrative #2: Excessive Government Spending
If wages did not fuel inflation, austerity hawks blame its rise on the generous infusion of social spending into the economy in response to Covid. They ignore that this stimulus successfully maintained household incomes, stabilized tens of thousands of small businesses, and resulted in Canada ranking second best among G7 members in responding to the pandemic with the appropriate human services.
Just as important, government spending provided a launching pad, ensuring that Canada’s job growth and business recovery from the pandemic lockdown were among the most robust among world economies, surprising both politicians and economists. Fiscal rules were suspended to accommodate the government spending necessitated by the pandemic.
As economist Stephanie Kelton among others have noted, many governments including Canada have the fiscal flexibility to substantially increase spending and, in fact, do not need to borrow funds from private banks to do so.
Oddly enough, it is precisely the astounding strength of the economic recovery to which the inflationary price increases have been attributed. The economy is overheated, we are told, demand outstrips supply though, as Jim Stanford has noted, Canadian workers are producing more than ever. The question is – can Canadians afford to buy the goods and services offered when both consumer income and business enterprises fall as interest rates climb?
The Real Story: Driven by Global Supply Factors
There are many factors that can influence inflation and most are largely out of the control of the Canadian government as well as of the Central Bank. Beside the COVID-pandemic, these include severe climate events, the war in Ukraine, including resulting economic sanctions, and structural inefficiencies in the container industry. These have combined to worsen supply challenges and create price spikes, particularly in key sectors such as energy and food.
In Canada, the focus on bringing down inflation is on the demand side when it should be on the supply side. Neither government stimulus spending to kick-start the economy nor wage increases to restore lost purchasing power are a problem as long as the supply of goods can increase in response to demand. But supply chain bottlenecks and resulting parts shortages have caused major problems. They appeared as a result of delays in transportation and rising fuel costs, by land but most notably by sea.
Long-standing structural inefficiencies in the container industry could no longer be hidden. A quarter of all containers sat empty on docks while supplies waited to the loaded and shipped from other ports. Of the seventeen million shipping containers in circulation around the globe, only about six million are in active use today. In America especially, many containers sit idle. This is because the country imports more than it exports and shipping the containers back to Asia would be too expensive for most businesses.
The impacts of climate change on driving up the prices of food, fertilizers and grain because of droughts, floods, pollution, or other natural disasters are often not given the attention they require. Christopher Flavelle, reporting in the New York Times warns that climate change could cut $23 trillion from the world economy by 2050. This is the actuarial estimate resulting from our collective failure to shift away from fossil fuels, to tackle diminishing crop yields, as well as the impact of the spread of diseases and rising sea levels on global wealth and living standards.
Profiteering From Supply Challenges in The Food and Energy Sector
In Canada, a lack of competition in the food sector and global opportunities to increase oil and gas production, have created a window for generating enormous windfall profits in these sectors. A recent Oxfam International report found that food and agribusiness billionaires reportedly raised their collective wealth by 42 per cent in the past two years, all while global food prices soared by 33.6 per cent in 2021 and are expected to rise by another 23 per cent throughout 2022.
Canadian Centre for Policy Alternatives (CCPA) economist David Macdonald found that grocery stores “booked $7.3 billion in pre-tax profit in 2021. That’s more than double what they were clearing the year before the pandemic.”
Lack of competition in the economy with many sectors dominated by only a small number of major players, created significant opportunities for profiteering and price gouging in response to the supply shortages. Excess profits in both the food and energy sectors have been widely reported and deplored. They reflect price increases well in excess of rises in the costs of production and distribution – a shift in incomes from the pockets of consumers to the wealth of owners and shareholders.
We are on the wrong track. Obsolete thinking is creating a recession, tens of thousands of lost jobs and a further diminishing of living standards for many workers may swell some corporate bottom lines but it doesn’t improve human health or create a broadly shared prosperity. It can’t because it’s a one dimensional approach that hurts workers and communities, and has no direct impact on the global factors that are driving the problem.
Faced with the plurality of factors fueling inflation, most of which are outside the purview of the Bank of Canada, its current fixation on massively raising interest rates seems spurious and even malicious. It signals a misguided effort to revive neoliberal austerity measures rather than a sound strategy to create jobs and build prosperity.
The Bank of Canada must be reminded that since the 1980s, the era of “inflation first” monetary policy, workers share of national income has declined significantly, particularly so since the Global Financial Crisis in 2008. As is well known, the reason workers share of national income declined was because real wages were flat while the economy’s productivity grew, thereby expanding the shares of profit and interest income at the expense of labour’s share.
Part two can be found here.