Tiff Macklem, Governor of the Bank of Canada, at the Globe and Mail Centre on Sept. 10, 2020.Fred Lum/The Globe and Mail
When Bank of Canada Governor Tiff Macklem faces the media this Wednesday after what is sure to be another sharp interest-rate increase, reporters will almost certainly ask him some version of “Do you expect a recession?” or “Are you trying to engineer a recession?”
Mr. Macklem’s answer will boil down to “No.”
But would he and his colleagues be upset if their aggressive interest-rate hikes lead to a quarter or two of shrinking demand for goods, services, and even for labour? Of course not. That’s the objective of the rate hikes.
“But hey, isn’t that a recession?” comes the cry from the cheap seats.
Well, no, actually, it isn’t.
The distinction is more than semantics. It defines the fine line that the central bank is trying to walk.
Millions of prime-working-age Americans have disappeared from the labour force. Not in Canada
The question of a Canadian recession reached new heights last week, when Royal Bank of Canada’s economics team became the first among the country’s big banks to formally forecast a “recession” – albeit one that “will be moderate and short-lived by historical standards.” More specifically, the bank projects that gross domestic product will shrink by 0.5 per cent in each of the second and third quarters of 2023.
And it identified the Bank of Canada’s rate hikes as the primary catalyst for this downturn.
“Higher rates will technically push Canada toward contraction,” RBC said in a report last Thursday – while acknowledging that the central bank “has little choice” if it’s going to quell the serious threat posed by inflation.
First, it’s notable that RBC is the outlier here; economists at the rest of the country’s banks do not predict a single quarter of outright GDP decline, let alone two in a row. But what RBC describes as a “moderate recession” is, arguably, not a recession at all.
Yes, it fits the loose definition of a recession that has, not particularly helpfully, been embraced by a lot of armchair economy-watchers: two consecutive quarters of decline in GDP. (You’ll sometimes see the two-consecutive-quarters criterion referred to as a “technical recession.” In fact, it’s probably the least technical of all definitions. It’s technically wrong.)
Typically, a GDP downturn is only one indicator. For an economy to truly be in recession, there’s a lot more that has to be going wrong. What economists look for is evidence of a sustained decline in activity across the entire economy.
The National Bureau of Economic Research, which has long been the official arbiter of what does and does not constitute a recession in the United States, looks to a range of additional indicators – including employment, real income, industrial output, and wholesale and retail sales – to determine if a downturn in GDP constitutes a recession. In Canada, the C.D. Howe Institute’s Business Cycle Panel takes a similar broad approach to calling recessions.
It’s fair to say that, among these criteria, a downturn in the labour market is pivotal. You can’t have a true recession if employment remains strong.
The U.S. economy might have just gone through exactly that sort of thing: a two-quarter contraction in GDP (the 2022 first quarter and, by some estimates, the second quarter) that has not been accompanied by a labour slump. Canadian Imperial Bank of Commerce chief economist Avery Shenfeld dubbed it a “noncession.”
“The very definition of a recession essentially rules out having one without job losses,” Mr. Shenfeld said in a research note last week.
Which brings us back to the situation the Canadian economy finds itself in, and where the Bank of Canada has room to manoeuvre.
There’s little question that Canada’s labour market is suffering from a historic imbalance of supply (not enough) and demand (way too much). The unemployment rate is at half-century lows. The country had nearly a million job vacancies in the first quarter of this year, up more than 70 per cent from prepandemic levels.
Those numbers suggest that you can remove a great deal of demand before you tip the scales in the other direction. Even in RBC’s “recession” scenario, the bank sees unemployment climbing to 6.6 per cent – a rate that “wouldn’t be far above long-run full employment levels,” the bank acknowledges. That sounds like a labour market more or less in balance. Hardly the kind of hardship associated with past recessions.
It’s not just labour that’s in a state of excess demand in this country; the Bank of Canada said in the spring that “a broad set of measures” showed that the economy was operating beyond its productive capacity. Which suggests it’s possible to have an economic slowdown that merely brings demand for labour, goods and services back in balance with supply.
This is the needle that the Bank of Canada is trying to thread. It won’t be easy; rapid rate hikes have tipped overheated economies into recession before, and they absolutely could do so again.
But with so much excess demand, especially in the labour market, we’re still a long way from that tipping point. In our current state, a bit of economic correction just doesn’t add up to recession, not in the way we usually think about it.
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