Recession? What Recession?

 

With the Bank of Canada’s recent rate hike and the expectation that there may be another hike in July, the talk of an economic slowdown and a recession has ramped up.  There is talk and rumor of looming  recession and that has been underway for some time.  At the same time, another view is that we risk moving into a 1970s style economic environment if inflation is not soon brought to heel. Given the lag between tighter monetary policy and the economic slowdown that would bring inflation down, it is possible that any downturn is still up ahead.  At the same time, the evidence to date suggests the economy is not yet slowing down.  Despite higher interest rates, demand is still being fueled by pent up consumer revenge spending, robust population growth – more people means more consumption spending - and residual post-pandemic savings. 

 

 

 

Figures 1 to 3 show that key economic indicators after post-pandemic re-bound and adjustment remain robust.  Figure 1 presents the Canadian City CPI total inflation rate (from FRED) and while it has been coming down it is still over five percent and high by the standards of recent history.  Figure 2 shows quarterly real GDP growth and while recent growth at about 2 percent is down substantially from the pandemic rebound, it is akin to pre-pandemic growth.  There have been no two consecutive quarters of negative real GDP growth – a traditional hallmark of a recession.  And while 2 percent growth is not great, that is more a long-term productivity growth problem than anything to do with rising interest rates and recessions.  And then there is Figure 3 which shows we are currently at the lowest unemployment rate in over a decade – again more a sign of an overheating economy rather than a harbinger of recession.  

 

 

 

 

 

So, it would appear that until there is evidence to the contrary, at least another interest rate increase by the Bank of Canada is in the offing.  The economy is still growing, labor markets are tight, and inflation remains high by historical standards.  The current level of interest rates seems to be compatible with ongoing inflation in the 4 to 5 percent range and is unlikely to bring us to the target 1 to 3 percent range of days of yore.  Keeping inflation at the 4 to 5 percent range is dangerous given that any demand or supply side shock when inflation is already in the 4 to 5 percent range could bring us to double digit inflation – a 1970s style scenario.

Is Ontario's Rising Cost of Living Really That Bad?

The news currently is full of stories about the rising cost of living whether it is grocery prices, rents, housing or energy.  The release of April’s CPI inflation rate shows it nudging upwards once again to 4.4 percent raising the spectre of further interest rate increases down the road.  Apparently one fifth of Canadians feel they are completely out of money as inflation “bites.” And along with the usual afflictions on budgets, inflation is apparently also taking a toll on entrepreneurial mental health. Needless to say, those of us of a certain vintage who remember the double digit inflation and interest rates of the early 1980s sometimes wonder if part of what is going on here needs to be interpreted within the context of life experience.  That is, if you are in your 30s and 40s, what is currently underway is an extreme price shock whereas if you are in your 50s and 60s the current inflationary and cost of living surge is relatively modest.

 

What does the evidence say?  Well, the accompanying figure plots a number of times series starting from 1990 using Ontario data.  For all of them, it sets 1990 as the base year and equal to 100 thus allowing us to see how what the increases  have been for all the series in a standardized way.  The data for rents for Toronto and Ontario is from CMHC, the CPI and nominal GDP per capita from Statistics Canada and the Ontario minimum wage you can get online from an assortment of sources. As the figure shows, the cost of living in Ontario has gone up since 1990.

 

 

 

For example, since 1990 the average rent for a Toronto two-bedroom apartment has gone from $689 to $1811 per month -a 163 percent increase.  Needless to say, being an average it masks the fact that at the margin, someone looking for a two bedroom in Toronto right now will likely face rents of over 3,000 a month if not more. For Ontario as a whole, average rents have gone up similarly from $576 to $1511. At the same time, the going market rate for a new rental ranges widely across Ontario also with two-bedrooms going for $3,290 in Toronto to $2,262 in Hamilton to $2,050 in Kingston - all above the “average” for all rented units.

 

With respect to the average rents, the increases in the accompanying figure are spread out over thirty years and while higher than the increase in the CPI, they matches pretty closely to the rise in nominal per capita GDP which has risen 167 percent.  Of course, one often sees the argument that the working poor cannot keep up but the Ontario minimum wage from 1990 to 2023 has gone up 206 percent – faster than average rents (162 percent), inflation (103 percent) or per capita GDP (167 percent).

 

So, what is the problem?  I think the problem is the rapidity of the recent increases relative to the resources available to pay.  From 1990 to 2010, the average rent for a two-bedroom in Toronto rose 63 percent or an average of 3 percent annually.  Over the same period, average rents in Ontario rose 61 percent (or just under 3 percent annually) and the CPI rose 48 percent (about 2.3 percent annually).  Meanwhile, hourly minimum wages rose almost 90 percent (4.5 percent annually) (on average) while per capita GDP rose almost 80 percent (4 percent annually).  This suggests that resources  were able to keep up with rising prices.

 

For the 2010 to 2022 period, the average rent for a Toronto two bedroom rose 58 percent (about 4.9 percent annual average) with the Ontario average also at 4.9 percent annually.  As well, the CPI rose 31 percent (at 2.6  percent annually on average). However, much of the "pulling up" of the average has occurred since 2019 – the pandemic era.  Meanwhile, since 2010, the minimum wage has grown 51 percent (at 4.3 percent annually) while nominal per capita GDP rose 45 percent (annual growth at 3.8 percent).  All of this is notwithstanding the reality that if you have been renting the same place for the last 15 years and are rent controlled, your experience is different from someone who needs to find a new rental right now. 

 

Ultimately, the period from 1990 to 2010 in Ontario was all things given a relatively more prosperous period than 2010 to 2023.  What seems to have happened is that in general the public over the period 1990 to 2010 experienced low interest rates, relatively low inflation and fairly robust economic growth which translated into a relatively easier time of making ends meet than the period since 2010.  The period since 2010 started with low interest rates but are now seeing higher interest rates, higher inflation and lower GDP growth.  For anyone born after 1980, the current experience is undiscovered country.  Needless to say, there are a lot of unhappy campers.  So, the crux of the matter seems to be that there has been a surge in cost but not accompanied by the economic productivity that would afford a greater ability to pay.  For those at the lower end of the income distribution, the average annual increases in the minimum wage have on average been higher than the increase in nominal per capita GDP but that is little comfort if you need to find a new place to live at current market rents. 

Inflation and Unemployment

 My most recent post on the Fraser Institute Blog dealt with an international comparison of inflation and unemployment. Enjoy.

Unemployment and inflation—Canada’s worrying numbers

— December 3, 2021

With the inflation debate in Canada focusing on whether this inflation is transitory or not, we’ve seen little discussion about how our inflation compares with other advanced economies.

The International Monetary Fund released its update of the World Economic Outlook Database in October and there are now updated estimates for 2021 and beyond. While monthly consumer inflation in Canada (according to Statistics Canada) is currently pushing 5 per cent, our consumer inflation for 2021—as estimated by the International Monetary Fund (IMF) using consumer prices—is expected to be closer to 4 per cent.

For the major 35 IMF advanced economies, consumer inflation in 2021 is expected to average 2.8 per cent, putting Canada well above the average. The rates are expected to range from highs of 7 per cent for Estonia and 5 per cent for the United States to lows of just under 1 per cent for Switzerland and Japan. At 3.8 per cent, Canada’s inflation rate for 2021 is expected to rank 6th highest of the 35 IMF advanced economies.

Of course, some might argue that a little inflation might be just the lubricant needed to help pandemic-stricken economies rebound given the traditional macroeconomic relationship (provided by the Phillips Curve) between inflation and unemployment, which posits an inverse relationship between the two variables. That is, high inflation rates have been associated with low unemployment rates whereas lower inflation rates have often been accompanied by higher unemployment rates.

This would suggest that across these countries, if Canada has a higher inflation rate, then it should also have a markedly lower unemployment rate.

However, that does not appear to be the case. Again, the IMF estimates for 2021 reveal an average unemployment rate for the 35 IMF advanced economies at 6.2 per cent with Canada again above the average at 7.7 per cent. The highest rates are just over 15 per cent for Greece and Spain while the lowest are expected in Japan and Singapore at just under 3 per cent. Indeed, Canada is expected to have the 8th highest unemployment rate of these advanced economies.

Higher unemployment and higher inflation—once termed “stagflation”—is a truly miserable macroeconomic outcome. Indeed, the sum of the inflation rate and the unemployment rate has been dubbed the Misery Index and a quick calculation of this index for these advanced economies puts Canada in the 6th highest spot. As the chart below illustrates, the most “miserable” advanced economies in 2021 are expected to be Spain, Greece, Estonia, Latvia, Italy and Canada with the combined sum of the inflation rate and the unemployment rate ranging from 17.9 per cent to 11.5 per cent.

 

CanvasJS.com

At the bottom in terms of misery are Taiwan, Singapore, Switzerland and Japan ranging from 5.4 per cent to 3.5 per cent.

For Canadians, the adage that misery loves company will be cold comfort given the higher costs of food, energy and rent that have marked the last few months. While many might argue that our inflation is not as severe as that of the U.S., with our unemployment rate remaining higher than other countries (including the U.S. at 5.4 per cent), Canadians are indeed left wondering if 2022 will be better or worse.

Municipal Government Inflation Rates: How Much higher?

On Tuesday night this week, Thunder Bay City Council began its budget deliberation process and there was a fair amount of grilling of City Administration by councilors with respect to the overview of where spending and tax rates would be going over the next few years.  Apparently, councilors were surprised when Administration said that the city had a $20 million annual infrastructure gap for the next 15 years as well as projected tax increases at over 3 percent – 3.83 percent for 2020 alone – until 2024.  Part of the questioning involved the standards being applied to estimate the infrastructure gap and clarification was requested. This of course is a reasonable question given the extremely wide range of estimates available for infrastructure gaps at least at the national level.

I tuned in for a bit on Tuesday night and caught part of an exchange between Councilor Mark Bentz and City Manager Norm Gale in which Councillor Bentz expressed some disquiet at the projected tax increases until 2024 being well in excess of increases in the Consumer Price Index inflation rate. The reply from the City Manager was that the Municipal Consumer Price Index was not the same as inflation from the Consumer Price Index and that it was indeed much higher.  So, I decided to do a little digging to see what the source of such a statement might have been and to see indeed how much higher an inflation rate you could get for government spending in general.

It turns out the City of Edmonton actually did a bit of research into this issue and published a report titled Municipal Price Index 2018 in which they compared consumer inflation and municipal inflation from 2012 to the present and provided some forecasts for the future. It turns out that based on their estimates for Edmonton, the inflation rate for municipal government services was indeed higher than for consumer prices but as Figure 1 illustrates, the gap is not as large as one might think. Over the entire period 2012 to 2019(forecast), the average consumer price inflation rate for Edmonton was 1.6 percent while the average municipal inflation rate was 2.2 percent for an average difference of 0.7 percent.  
 

So, what about Thunder Bay?  Well Figure 2 plots the inflation rate since 2012 for Thunder Bay based on the CPI.  It then plots inflation based on the Government Expenditure Implicit Price Index obtained from the 2018 CIHI National Health Expenditures Data Appendix A.  It then also plots the municipal inflation rate for Edmonton from Figure 1 and the annual increases in Thunder Bay’s municipal tax levy.  Note that for 2019, the CPI Inflation rate for Thunder Bay and the GEIPI rate are both assumed to be 2 percent.  So, what do we get?

Thunder Bay’s municipal tax levy increases since 2012 and forecast into 2019 are generally all well above any of these measures of inflation including the municipal inflation rate calculated by the City of Edmonton. The average CPI inflation rate for Thunder Bay over the 2012 to 2019f period is 1.5 percent.  The inflation rate based on the Government Expenditure Implicit Price Index (GEIPI) is 1.4 percent while the municipal inflation rate for Edmonton is 2.2.  The average Thunder Bay municipal tax levy increase for this period was 3.3 percent.

So, unless one is going to argue that municipal “inflation” in Thunder Bay is nearly double that for consumer prices – and I would need to see some evidence for that rather than just a blind assertion by City Administration – then one would have to conclude that this year’s 3.25 percent proposed increase in the tax levy is too high.  Obviously, the rate of municipal inflation is going to be partly determined by the City in terms of what they negotiate to pay for various goods and services as well as the choices of what goods and services to consume or provide.

If we go with the Edmonton forecast for municipal inflation of 2.7 percent – then to bring the tax levy down from 3.25 percent to 2.7 percent, there needs to be about $1.7 million dollars in reductions from this year’s proposed tax levy increase.  If you want to bring the levy down to a two percent increase, then there would need to be a $2.4 million reduction in the proposed levy.  So, whichever way you look at it, we can probably do better than 3.25 percent this year.