A pandemic, a war, rising inflation and interest rate hikes. All the ingredients that cause recessions are currently in place. Despite a booming economy, Canada is not immune to a sharp slowdown in growth.
Posted at 5:00 am
Recession risks are on the rise, most economists agree. Since the Bank of Canada made clear that it plans to raise interest rates quickly to curb inflation, the likelihood of a recession has increased, said Steve Ambler, an associate professor at the School of Management University of Quebec in Montreal and holder of the the David Dodge Chair in Monetary Policy.
“Current interest rates, which are still very low after two hikes this year, will need to rise much more to fight inflation, which exceeds the Bank of Canada’s target of 4.6%,” he said.
How high can interest rates rise before the economy starts to falter? The Bank of Canada envisions a so-called neutral rate, which will allow the economy to grow without causing inflation. According to the monetary authorities, this ideal (and theoretical) interest rate is around 2.5%.
But with inflation currently above 6%, it is almost certain that interest rates will have to remain above this neutral rate for some time to come, says Steve Ambler.
The economy starts to suffer when interest rates exceed this considered ideal rate. The Governor of the Bank of Canada believes that the Canadian economy can withstand higher interest rates. The central bank is forecasting economic growth of 4.2% this year and 3.2% in 2023. Even if these forecasts prove too optimistic, there is still some margin before they enter negative territory, Tiff Macklem argued again last week. federal elected officials.
A recession, if necessary
The recession, if there is one, is not for this year, say several economists, including Jean-François Perreault, chief economist at Scotiabank. The Bank of Canada has taken its foot off the accelerator, but has not yet applied the brakes, he believes. Rate increases will slow the machine down, but it still has enough fuel to keep it going for several more months, he said.
The situation is different in Europe, where the war in Ukraine and rising energy prices have caused an economic shock.
Much of the current concern about the likelihood of a recession stems from what is happening in Ukraine. It is likely that several countries in Europe will be in recession.
Jean-François Perreault, chief economist of Scotiabank
If that happens, Canada will not suffer too much because it is a producer of raw materials that will find buyers elsewhere if the European economy freezes. On the other hand, if the US economy suffers, the northern neighbor will not escape.
On this side of the Atlantic, the biggest risk is inflation, Jean-François Perreault says, and how central banks will combat it.
Raising interest rates will not lower the prices of oil and other commodities, but it will calm consumption and the real estate frenzy. The Scotia economist points out that the Bank of Canada has repeatedly stated its determination to bring inflation back to its 2% target, suggesting it wants to achieve that at any cost, even at the cost of a recession.
Interest rates that are too high for too long will inevitably lead to a recession. At least that is what recent history teaches us.
“It is an avoidable scenario, however, says Jimmy Jean, chief economist at Desjardins, but a number of things have to go right. †
First, central banks in both Canada and the United States must raise their rates more vigorously to stop stimulating the economy. “The longer we wait, the greater the risk that we will have to raise interest rates further and longer. It could take 18 to 24 months for interest rate hikes to have an impact on the real economy, he said.
If inflation shows signs of slowing or leveling off, the chances of a soft landing increase, says Jimmy Jean.
Finally, there should be no other shocks hitting the global economies.
Will the current combination of pandemic, war and inflation lead directly to a recession? Everything depends on the results of the Bank of Canada and the United States Federal Reserve in the just-started fight against inflation.
Three scenarios are possible, summarizes Miville Tremblay, fellow of the CD Howe Institute and CIRANO, which is also a former Bank of Canada.
“The ideal is a soft landing, with demand calming down a bit and inflation approaching 2% in a year or two,” he says. The second is stagflation, where growth falters a lot but inflation persists due to shortages and supply shocks. The third is that of a recession where the rise in rates breaks the reins of growth. †
It is very difficult, he said, to tie probabilities to these scenarios because of the unusual combination of factors currently affecting the global economy. “We have to wish each other every success! he concludes.
The ABC’s of the recession
A recession is a decline in economic activity, measured by gross domestic product (GDP), for at least two consecutive quarters. It is characterized by a significant rise in unemployment and a marked fall in consumption and investment which may last for several months or several years.
course of action
The damage of a recession is measured in loss of production, but also in human tragedies caused by job losses, bankruptcies and a drop in living standards.
A downturn in the economy is rarely caused by a single factor or event. It is usually the result of a variety of causes, such as excessive debt, speculative bubbles or a shock caused by a pandemic, ultimately fueling inflation.
Canada’s latest recessions
The pandemic triggered a sudden and short-lived recession, very unlike other periods of decline in the Canadian economy. Before the big plunge of 2020, the last “normal” recession was in 2008.
The weak Canadian dollar and rising inflation prompted the Bank of Canada to raise interest rates and keep them high, triggering Canada’s longest recession since the 1930s.
Duration: 6 terms
Key interest: 21%
Unemployment rate: 12.8%
GDP decline: 4.9%
It was again the fight against inflation through interest rate hikes that sent Canada into recession in 1990. Unlike the others, this recession was not caused by a slowdown in the US economy and was considered the first recession Made in Canada†
Duration: 5 terms
Key rate: 14.5%
Unemployment rate: 12%
GDP decline: 3.4%
The financial crisis in the United States and the collapse of the American real estate sector have shaken the international financial system and pushed the Canadian economy into recession.
Duration: 3 terms
Key rate: 4.5%
Unemployment rate: 9%
GDP decline: 3.6%