Prime Minister Justin Trudeau and Immigration, Refugees and Citizenship Minister Marc Miller are joined by fellow members of Parliament as they hold a press conference on Parliament Hill in Ottawa on Oct. 24.Sean Kilpatrick/The Canadian Press
Charles St-Arnaud is chief economist at Alberta Central.
The federal government recently announced drastically lower immigration targets for 2025, 2026 and 2027. By reducing the number of new permanent residents over the next three years, the latest move to pause population growth is aimed at easing pressure on the country’s housing market, infrastructure and public services.
As a result of the new targets, Canada’s population is expected to decline slightly by 0.2 per cent in 2025 and 2026, before returning to growth of 0.8 per cent in 2027; a sharp deceleration considering population grew by 3.2 per cent in 2023 and 3 per cent in the 12 months leading up to July, 2024.
Such a demographic slump will not be without consequences for the economy.
The sharp increase in population in recent years can be fully credited for keeping the economy afloat. If it were not for the rise in population pushing aggregate consumer spending higher, economic activity would have contracted in the second half of 2023. Hence, the Canadian economy would have been in a recession.
The current situation can be referred to as a “Me-cession.” In other words, collectively, we are spending more and pushing economic activity higher, but individually, we are restricting purchases and behaving like in a recession. As such, the recent data on consumer spending show that individuals are still reducing their spending, as evidenced by declining real consumer spending per capita. It is only population growth that has been propping up spending.
In addition, the labour market’s resilience can also be linked to strong population growth. With aggregate demand continuing to increase because of a larger population, most businesses have not seen a decline in overall activity. Hence, they still require the same number of workers as before, thus preventing layoffs and reducing the risk of a hard landing.
With population growth expected to stall over the next two years, there will be significant consequences on the Canadian economy’s supply and demand side.
On the supply side, the drop in population growth will mean that potential GDP growth will drop significantly. The lower potential growth will mean that the amount of excess capacity in the economy could be reduced more rapidly than expected, depending on GDP growth.
On the demand side, unless consumers start spending more individually, declining aggregate spending will be a drag on growth. Stalled or lower economic activity could force some businesses to reduce their headcount, potentially affecting the economy, from lower spending to increased financial stress for some households.
Over all, while it is unclear whether the shock will lead to more or less excess capacity in the Canadian economy, what is certain is that economic growth will be much weaker in 2025 and 2026 than initially expected. This lower growth rate will mean there is very little room to manoeuvre between economic expansion and contraction, increasing the likelihood that the Canadian economy could be in a recession.
The changes to the economic outlook will also have implications for the country’s monetary policy.
First, the Bank of Canada may consider rapidly reducing its policy rate to stimulate domestic demand. The BoC could bring forward a recovery by accelerating the pace of rate cuts. This is especially true since, with further interest-rate cuts widely expected in the coming months, a case can be made that many people and businesses are waiting for interest rates to reach their bottom before taking advantage of lower interest rates, hence delaying the positive impact of lower rates. Otherwise, there is a risk that the sharp deceleration in economic activity could lead to a recession.
Second, sharply weaker potential growth in 2025 and 2026 suggests that the neutral interest rate, which neither stimulates nor dampens the Canadian economy, will likely be lower than initially thought, currently estimated at between 2.25 per cent and 3.25 per cent by the Bank of Canada. This implies that the Bank of Canada may need to reduce its policy rate further, meaning that the bottom in interest rates in the current cycle may be much lower than expected by various observers.
However, we should be concerned with the potential impact of much lower interest rates and a potential return to the unsustainable growth model of the past decades that was based on ever-growing household borrowing, especially residential mortgages, that crowded out business investment, leading to Canada’s poor productivity record over the past three decades.
The recent years are an example of how Canada’s immigration policies can dramatically affect the economy. The government went from one extreme, the population growing too fast, to another, growing too little. This volatility shows that both extremes can lead to economic challenges.