LABOUR MARKET IMPACTS OF SOFT AND HARD LANDINGS
Jim Stanford
On January 25th, the Bank of Canada implemented its eighth consecutive increase in its trend-setting interest rate in 120 months, taking its policy rate to 4.5%. Governor Tiff Macklem also indicated the Bank now plans to wait and watch for a while, to judge the effects of this record monetary tightening on inflation and on the real economy.
However, he remains “resolute” in his crusade to get inflation (which peaked at 8% last June, and is now running at about 6%) back to the Bank’s 2% target. If more interest hikes are necessary to achieve that goal, the Bank will not hesitate. But if the economy slows down as the Bank currently forecasts (very likely), and if inflation quickly abates as a result (not so certain), then Macklem suggested last week’s increase could be the last in this tightening cycle.
The Bank’s official forecast predicts a ‘soft landing’ scenario: in essence, the economy would pause for breath in 2023, with growth effectively stopping for a few months. The bank acknowledges this could entail a short, shallow recession by the conventional measure (which defines a recession as two consecutive quarters of negative GDP growth). However, the Bank does not expect a significant decline in either output or GDP, as would be the case in a more full-fledged downturn.
What are the implications of this hoped-for ‘soft landing’ for Canada’s labour market? With growth simply stopping for a while, but no major contraction in output, a soft landing would not likely produce large job losses. Firms would need most of their existing workers to keep producing their current output of goods and services.
Some layoffs are certainly possible: in part because some sectors will be shrinking as the overall economy pauses (we’ve already seen this in technology, forest products, and some other industries). Moreover, gradual productivity growth over time means the economy can produce the same amount of output with slightly fewer workers each year – implying modest employment declines even with stagnant aggregate output.
That could be offset by the normal time lags when companies downsize unneeded staff. We could even see a phenomenon called ‘labour hoarding,’ whereby employers don’t lay off workers even if they aren’t presently needed – in anticipation they will be needed in the future.
However, even if employment held steady, at the same time the labour force continues to grow: up by almost 200,000 in the last year. This reflects population growth – led now by immigration, which will accelerate in coming years under new federal targets. Higher labour force participation for women (supported by better access to child care, thanks to the new national program) also boosts labour supply.
Flat employment combined with growing labour supply means that unemployment would increase, even in a soft landing scenario. The unemployment rate in this case is likely to rise to 6% or higher over a year of flat growth. Since Mr. Macklem has explicitly said he wants higher unemployment (he argues the current 5% unemployment rate is “unsustainable”), he will be happy with an outcome which boosts joblessness but without a full-on recession.
Whether that soft landing would be enough to bring inflation down to 2%, however, is not at all certain. After all, the surge in inflation after the COVID lockdowns was not primarily due to an overheated domestic economy, and certainly not the result of wage pressures (to the contrary, real wages for Canadian workers have declined steadily over the last two years).
Most of that inflation was due to global and supply-side problems following the pandemic: disrupted supply chains, shortages of key commodities (like semiconductors and building supplies), followed by a global energy price spike after the invasion of Ukraine. Those supply-side factors are abating, and that will help bring down inflation. But will it be enough to get inflation low enough, fast enough for Mr. Macklem’s liking? If it isn’t, we could see further interest rate hikes later in 2023 – simultaneous with a rapid slowdown in economic growth.
If the soft landing scenario prevails, it will be claimed as a ‘victory’ by the Bank of Canada and its supporters. But a year of zero growth and modestly higher unemployment can only be considered laudable in comparison to the alternative: which right now is a longer, deeper downturn, that many economists (myself included) fear is the more likely result of rapid monetary tightening. More fundamentally, stopping Canada’s economy dead in the water, at a moment when we need to do much more to repair and strengthen our economic and social condition, is certainly nothing to celebrate.
Indeed, contrary to the ‘overheating’ narrative propagated by the Bank of Canada, Canada’s GDP is still well below its pre-COVID trend. The gap between what we currently produce, and what we likely would have been producing absent the pandemic, is currently around 3% – and that gap is growing (see figure below). In short, we haven’t yet fully repaired the economic damage from the pandemic, but the Bank of Canada nevertheless wants to freeze growth for roughly a year. Even a soft landing would lock in a condition of painful underutilization – at a moment when our economy should be doing more, not less (from fixing health care to building affordable housing to rolling out green energy).
Worse yet, Mr. Macklem’s recent speeches indicate he will then make sure unemployment stays higher. He has resuscitated an old theory called the non-accelerating inflation rate of unemployment (or NAIRU). In this worldview, unemployment must be kept sufficiently high to discipline workers and suppress wage growth. Macklem would thus need to continually stifle growth even after the soft landing, to make sure unemployment doesn’t fall ‘too low’ again.
NAIRU models have been notoriously inept at identifying true limits to the productive capacity of economies, and have thus been largely discredited in economic theory. Mr. Macklem’s return to this old-time economic religion signals deliberate labour market restraint for years to come. Perversely, one of Canada’s most outstanding economic achievements – namely, reducing unemployment to its lowest rate in a half-century – is now viewed by Mr. Macklem as a problem, one that must be firmly and permanently corrected.
In sum, even the hoped-for soft landing – deliberately grinding the economy to a halt, at a moment when Canadians are still rebuilding after COVID – would constitute a painful failure of economic management. Whether this soft landing produces an actual ‘technical’ recession (two consecutive quarters of negative growth) is largely irrelevant. Even if it doesn’t, it deliberately suppresses work, incomes, and opportunity, at a moment when we are still far below our true economic and social potential.
There is a big risk, however, that coming months will see something much worse: a ‘hard landing,’ marked by a sustained decline in output and employment (not just a ‘pause for breath’). This outcome would be comparable to the serious recessions Canada experienced in the early 1980s and early 1990s – and for similar reasons. Then, too, a commitment to rapid disinflation engineered through aggressive interest rate increases led to painful recessions, which scarred economic and social conditions for years to come.
In a hard-landing scenario, real GDP would fall significantly (likely by 2-3% over 6-8 quarters), and employment would fall accordingly (likely losing 300-400,000 jobs). In this case, with growing labour supply now combined with falling (not stable) employment, the unemployment rate would surge to 9% or even higher.
This sounds pessimistic, but there are ample signs that Canada’s economy (despite surprisingly positive job-creation numbers at end-2022) is sliding quickly into outright contraction. Consumer spending already started shrinking last fall, burdened by a record-breaking increase in interest payments by households. Residential construction (Canada’s most vibrant economic engine through the pandemic) has already fallen 20% since early 2021. GDP numbers were buoyed temporarily in 2022 by a record-breaking accumulation of inventories, as companies rebuilt stockpiles depleted by the supply chain problems during the pandemic. That will shift into an inventory drawdown as consumer demand flags, exacerbating the coming decline in output. So far, business investment and exports have kept growing. But with two-thirds of Canadian businesses telling the Bank of Canada they expect recession in 2023, and the global economy heading for a major downturn, these will likely soften, too.
It takes 12-24 months for the impacts of interest rate changes to be fully felt in the real economy. This means that even the very first Bank of Canada rate hike last March has not yet been fully digested, let alone the seven that followed it. Most of the effects of this tightening are still ahead of us – including the panicked efforts by households to find hundreds of dollars per month of spare cash to service their mortgages.
Some have argued that any decline in GDP resulting from this tightening can be absorbed without the large job losses experienced in previous recessions, because of the high number of current reported job vacancies. This is wishful thinking. Posted job vacancies don’t produce. If a company’s output shrinks (which, in aggregate, is what defines a recession), it does not simply stop advertising for more workers. Its existing workforce is now too big, relative to shrinking demand for its products. Hard-pressed firms will inevitably downsize, in broadly similar proportion to the decline in output.
Moreover, current job vacancy statistics are quite misleading. The rise of ubiquitous and inexpensive on-line job websites does not provide an accurate depiction of true labour demand. Companies can routinely post vacancies as part of regular HR practices, but these advertisements cannot be interpreted as proof of ‘empty desks’ in workplaces. A good example is the very high number of job vacancies reported by employers in the hospitality and retail sectors. Their vacancy numbers are perpetually high: not because of any genuine labour shortage, but because of the poor pay and conditions which result in rapid turnover. If consumer demand for retail shopping and restaurants declines (as is inevitable in a recession), then these sectors will certainly lay off staff – regardless of how many vacancies they are currently advertising.
History suggests the hard landing is in fact the more likely outcome of the Bank of Canada’s aggressive rate hikes. Indeed, Canada has never experienced an equivalent decline in inflation (the Bank hopes for a deceleration of 6 percentage points, from last year’s peak back to its 2% target) or an equivalent run-up in interest rates (up 4.25 percentage points in just 10 months) without experiencing a full recession.
The costs of a serious downturn (economic, social, and human), will be immense. The life trajectories of millions of people will be altered by unemployment, non-participation, and hopelessness. In my judgment, the risks of this outcome far outweigh the benefits of wrestling down post-COVID inflation – an obviously unique and temporary consequence of an unprecedented global pandemic – just a little bit faster.
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ABOUT THE AUTHOR:
Jim Stanford - Jim Stanford is Economist and Director of the Centre for Future Work, a labour economics think tank with offices in Vancouver and Australia.
The views and opinions expressed are those of the author and do not necessarily reflect the position of Air Quotes media. Read more opinion contributions via QUOTES from Air Quotes Media.