Former Bank of Canada Governor Stephen Poloz, pictured Dec. 22, 2021, argued in a recent LinkedIn post that the strong wage gains over the past year do not automatically mean higher inflation.Ashley Fraser/The Globe and Mail
Canada’s labour statistics for September showed that the country’s wage growth remains persistently strong. For workers, that’s a good thing. For central bankers trying to suppress inflation, it’s a headache.
But is it a force that must be suppressed for the Bank of Canada to win its fight against inflation? Do higher wages necessarily mean higher inflation?
The central bank’s former boss isn’t so sure.
“There’s a tendency to describe the relationship quite mechanically,” Stephen Poloz said. “I’m just saying, hang on, there’s more than one thing in that chain of causality.”
Mr. Poloz took to LinkedIn this week to talk about wages and inflation, after Statistics Canada reported last Friday that average hourly wages increased 5 per cent year over year in September, up slightly from 4.9 per cent in August. That raised worries that the Bank of Canada might raise interest rates again this month, based on the logic that those wages will feed into prices, and keep the central bank from hammering inflation down to its 2-per-cent target.
But Mr. Poloz argued that the strong wage gains over the past year do not automatically mean higher inflation. He suggested, indeed, that there are ways for wages to rise without triggering a corresponding increase in prices.
“This connection between wages and inflation is shrugged off pretty quickly as a mechanical link. It’s possible that there’s a linkage – there’s no big inflation in history without wage inflation, we know they go hand in hand. But it’s not a mechanical relationship,” Mr. Poloz said in a telephone interview Wednesday.
Mr. Poloz has acknowledged in the past that he is, by nature, an optimist; his position here could be a manifestation of that. The Bank of Canada itself – under the leadership of Mr. Poloz’s successor, Tiff Macklem – has said repeatedly in recent months that this pace of wage growth is “incompatible” with sustainably returning inflation to the bank’s 2-per-cent target.
Still, Mr. Poloz provides some food for serious thought about the processes by which wages feed into inflation – or, don’t feed into it, if prevailing economic conditions are different.
He outlines the two key means by which the inflationary pressures implied by higher wages can be mitigated: by increases in productivity; and/or by decreases in profit margins for employers. One or the other, or a combination of the two, could allow workers to improve their incomes without fuelling a continuing inflation problem.
Neither seems to be happening at the moment.
Canada’s labour productivity – measured by gross domestic product per hour worked – has fallen for five consecutive quarters. Employment and labour costs have continued to grow, but they haven’t been matched by a commensurate increase in output.
Meanwhile, as Bank of Canada deputy governor Nicolas Vincent noted in a speech last week, companies have shown little willingness to absorb their rising costs and accept lower profit margins.
“Price increases have closely mirrored cost increases,” Mr. Vincent said. “Even if profit margins haven’t increased, consumers have been left to bear the full brunt of higher prices.”
But looking at the bigger picture, Mr. Poloz noted that workers’ share of total income in the economy “has never been lower than it is today.” We could be nearing an “inflection point,” as he put it, at which wages’ share of income stops declining and perhaps begins to inch back toward historical levels, while corporate profits’ share retreats toward historical norms. In such a case, he said, generally higher wage growth would be a restoration of balance, without fuelling inflation.
Meanwhile, Mr. Poloz suggested that the aging population – and in particular, the growing numbers of baby boomers hitting retirement – may be throwing a temporary wrench into Canada’s productivity numbers.
He noted that management jobs have surged by about 12 per cent in the past year, far greater than the 2.8-per-cent growth in total employment. He theorizes that businesses may be “doubling up” on managers in order to train replacements for senior staff who are nearing retirement. The result is more high-income staff, without generating any additional output.
“That’s a productivity burn right there,” Mr. Poloz said. But when those senior managers retire and make way for their replacements, he said, we could see some rebound in productivity.
In Mr. Poloz’s 2022 book, The Next Age of Uncertainty, he talks about five “tectonic forces” that he sees as making economic analysis and forecasting particularly complicated over the next several years: the aging population; income inequality; technological change; rising debt; and climate change. The first three may all play large roles in the direction of wages, productivity and inflation, and alter the way those measures interact.
“It’s got to confuse the signals that we normally look at,” he said.
None of which is to say, necessarily, that the current 5-per-cent annual pace of wage growth isn’t a looming inflation problem. But the relationship is more complicated than a straight line – and economic analysts will need to keep open minds as the data evolve.
“I’m not saying [wage growth] is not part of an inflation risk, or concern. It is. But it needs to be assessed with that broader lens over top of it.”